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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2016

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

 

 

CU BANCORP

(Exact name of registrant as specified in its charter)

 

 

Commission File Number 001-35683

 

California   90-0779788

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

818 West 7th Street, Suite 220

Los Angeles, California

  90017
(Address of principal executive offices)   (Zip Code)

(213) 430-7000

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer   ¨    Accelerated Filer   x
Non Accelerated Filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of August 2, 2016 the number of shares outstanding of the registrant’s no par value Common Stock was 17,671,272.

 

 

 


Table of Contents

CU BANCORP

June 30, 2016 FORM 10-Q

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

  

ITEM 1.

 

Financial Statements

  

 

Consolidated Balance Sheets

  
 

        June 30, 2016 (Unaudited) and December 31, 2015

     2   
 

Consolidated Statements of Income

  
 

        Three and Six Months Ended June 30, 2016 and 2015 (Unaudited)

     3   
 

Consolidated Statements of Comprehensive Income

  
 

        Three and Six Months Ended June 30, 2016 and 2015 (Unaudited)

     4   
 

Consolidated Statements of Changes in Shareholders’ Equity

  
 

        Six Months Ended June 30, 2016 (Unaudited)

     5   
 

Consolidated Statements of Cash Flows

  
 

        Six Months Ended June 30, 2016 and 2015 (Unaudited)

     6   
 

Notes to the Consolidated Financial Statements (Unaudited)

     8   

ITEM 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     40   
 

Overview

     42   
 

Results of Operations

     46   
 

Financial Condition

     56   
 

Liquidity

     61   
 

Dividends

     63   
 

Regulatory Matters

     64   

ITEM 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     67   

ITEM 4.

 

Controls and Procedures

     69   

PART II. OTHER INFORMATION

  

ITEM 1.

 

Legal Proceedings

     70   

ITEM 1A.

 

Risk Factors

     70   

ITEM 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     70   

ITEM 3.

 

Defaults Upon Senior Securities

     70   

ITEM 4.

 

Mine Safety Disclosures

     70   

ITEM 5.

 

Other Information

     70   

ITEM 6.

 

Exhibits

     70   

Signatures

       71   

 

Page 1 of 71


Table of Contents

CU BANCORP

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

     June 30,
2016
    December 31,
2015
 
     (Unaudited)     (Audited)  

ASSETS

    

Cash and due from banks

   $ 42,659      $ 50,960   

Interest earning deposits in other financial institutions

     194,681        171,103   
  

 

 

   

 

 

 

Total cash and cash equivalents

     237,340        222,063   

Certificates of deposit in other financial institutions

     54,410        56,860   

Investment securities available-for-sale, at fair value

     334,113        315,785   

Investment securities held-to-maturity, at amortized cost

     40,595        42,036   
  

 

 

   

 

 

 

Total investment securities

     374,708        357,821   

Loans

     1,951,111        1,833,163   

Allowance for loan loss

     (18,476     (15,682
  

 

 

   

 

 

 

Net loans

     1,932,635        1,817,481   

Premises and equipment, net

     4,647        5,139   

Deferred tax assets, net

     14,455        17,033   

Other real estate owned, net

     —          325   

Goodwill

     64,603        64,603   

Core deposit and leasehold right intangibles, net

     6,932        7,671   

Bank owned life insurance

     50,561        49,912   

Accrued interest receivable and other assets

     36,142        35,734   
  

 

 

   

 

 

 

Total Assets

   $ 2,776,433      $ 2,634,642   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

LIABILITIES

    

Non-interest bearing demand deposits

   $ 1,337,550      $ 1,288,085   

Interest bearing transaction accounts

     259,103        261,123   

Money market and savings deposits

     747,490        679,081   

Certificates of deposit

     51,598        58,502   
  

 

 

   

 

 

 

Total deposits

     2,395,741        2,286,791   

Securities sold under agreements to repurchase

     25,782        14,360   

Subordinated debentures, net

     9,777        9,697   

Accrued interest payable and other liabilities

     18,674        16,987   
  

 

 

   

 

 

 

Total Liabilities

     2,449,974        2,327,835   
  

 

 

   

 

 

 

Commitments and Contingencies (Note 13)

    

SHAREHOLDERS’ EQUITY

    

Serial Preferred Stock – authorized, 50,000,000 shares: Series A, non-cumulative perpetual preferred stock, $1,000 per share liquidation preference, 16,400 shares authorized, 16,400 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively

     17,086        16,995   

Common stock – authorized, 75,000,000 shares no par value, 17,668,381 and 17,175,389 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively

     234,141        230,688   

Additional paid-in capital

     25,209        23,017   

Retained earnings

     49,245        36,923   

Accumulated other comprehensive income (loss)

     778        (816
  

 

 

   

 

 

 

Total Shareholders’ Equity

     326,459        306,807   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 2,776,433      $ 2,634,642   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 2 of 71


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CU BANCORP

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(Dollars in thousands, except per share data)

 

     Three Months
Ended
June 30,
     Six Months
Ended
June 30,
 
     2016      2015      2016      2015  

Interest Income

           

Interest and fees on loans

   $ 23,165       $ 20,644       $ 45,743       $ 40,550   

Interest on investment securities

     1,415         1,051         2,647         2,231   

Interest on interest bearing deposits in other financial institutions

     417         246         856         448   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Interest Income

     24,997         21,941         49,246         43,229   
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest Expense

           

Interest on interest bearing transaction accounts

     99         98         198         198   

Interest on money market and savings deposits

     484         408         995         791   

Interest on certificates of deposit

     31         46         64         97   

Interest on securities sold under agreements to repurchase

     14         7         25         12   

Interest on subordinated debentures

     120         109         237         216   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Interest Expense

     748         668         1,519         1,314   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Interest Income

     24,249         21,273         47,727         41,915   

Provision for loan losses

     1,063         683         1,685         2,126   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Interest Income After Provision For Loan Losses

     23,186         20,590         46,042         39,789   
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-Interest Income

           

Gain on sale of SBA loans, net

     485         215         1,039         638   

Deposit account service charge income

     1,222         1,153         2,411         2,294   

Other non-interest income

     1,268         1,727         2,345         2,771   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Non-Interest Income

     2,975         3,095         5,795         5,703   
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-Interest Expense

           

Salaries and employee benefits (includes stock based compensation expense of $891 and $807 for the three months, and $1,725 and $1,320 for the six months ended June 30, 2016 and 2015, respectively)

     9,921         9,280         20,074         18,431   

Occupancy

     1,439         1,415         2,875         2,835   

Data processing

     635         635         1,253         1,276   

Legal and professional

     651         656         1,126         1,502   

FDIC deposit assessment

     359         351         709         684   

Merger expenses

     —           112         —           352   

OREO loss and expenses

     4         20         83         26   

Office services expenses

     320         407         723         821   

Other operating expenses

     1,760         2,036         3,433         3,898   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Non-Interest Expense

     15,089         14,912         30,276         29,825   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income Before Provision for Income Tax Expense

     11,072         8,773         21,561         15,667   

Provision for income tax expense

     4,427         3,506         8,629         6,201   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income

     6,645         5,267         12,932         9,466   

Preferred stock dividends and discount accretion

     307         312         610         584   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income available to common shareholders

   $ 6,338       $ 4,955       $ 12,322       $ 8,882   
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings Per Share

           

Basic earnings per share

   $ 0.37       $ 0.30       $ 0.72       $ 0.54   

Diluted earnings per share

   $ 0.36       $ 0.29       $ 0.71       $ 0.53   

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 3 of 71


Table of Contents

CU BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

 

     Three Months
Ended

June 30,
    Six Months
Ended
June 30,
 
     2016      2015     2016      2015  

Net Income

   $ 6,645       $ 5,267      $ 12,932       $ 9,466   

Other Comprehensive Income, net of tax:

          

Net change in unrealized gain (loss) on available-for-sale investment securities, net of tax

     825         (749     1,594         (238
  

 

 

    

 

 

   

 

 

    

 

 

 

Other Comprehensive Income (Loss)

     825         (749     1,594         (238
  

 

 

    

 

 

   

 

 

    

 

 

 

Comprehensive Income

   $ 7,470       $ 4,518      $ 14,526       $ 9,228   
  

 

 

    

 

 

   

 

 

    

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 4 of 71


Table of Contents

CU BANCORP

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Six Months Ended June 30, 2016

(Unaudited)

(Dollars in thousands)

 

     Preferred Stock      Common Stock                           
     Issued and
Outstanding
Shares
     Amount      Issued and
Outstanding
Shares
    Amount      Additional
Paid-in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Shareholders’
Equity
 

Balance at December 31, 2015

     16,400       $ 16,995         17,175,389      $ 230,688       $ 23,017      $ 36,923      $ (816   $ 306,807   

Net issuance of restricted stock

     —           —           109,809        —           —          —          —          —     

Exercise of stock options

     —           —           396,964        3,453         —          —          —          3,453   

Stock based compensation expense

     —           —           —          —           1,725        —          —          1,725   

Restricted stock repurchase

     —           —           (13,781     —           (305     —          —          (305

Excess tax benefit – stock based compensation

     —           —           —          —           772        —          —          772   

Preferred stock dividends and discount accretion

     —           91         —          —           —          (610     —          (519

Net income

     —           —           —          —           —          12,932        —          12,932   

Other comprehensive income

     —           —           —          —           —          —          1,594        1,594   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2016

     16,400       $ 17,086         17,668,381      $ 234,141       $ 25,209      $ 49,245      $ 778      $ 326,459   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 5 of 71


Table of Contents

CU BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

 

     Six Months Ended
June 30,
 
     2016     2015  

Cash flows from operating activities:

    

Net income:

   $ 12,932      $ 9,466   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for loan losses

     1,685        2,126   

Provision for unfunded loan commitments

     117        87   

Stock based compensation expense

     1,725        1,320   

Depreciation

     717        702   

Net accretion of discounts/premiums for loans acquired and deferred loan fees/costs

     (4,392     (4,121

Net amortization from investment securities

     1,991        1,536   

Increase in bank owned life insurance

     (649     (613

Amortization of core deposit intangibles

     642        842   

Amortization of time deposit premium

     (2     (10

Net (accretion) amortization of leasehold right intangible asset and liabilities

     (57     7   

Accretion of subordinated debenture discount

     80        80   

Loss on sale of OREO

     14        —     

Gain on sale of SBA loans, net

     (1,039     (638

Decrease in deferred tax assets

     1,421        435   

Decrease (increase) in accrued interest receivable and other assets

     364        (664

Increase (decrease) in accrued interest payable and other liabilities

     1,135        (395

Net excess in tax benefit on stock compensation

     (772     (451

Increase in fair value of derivative swap liability

     588        213   
  

 

 

   

 

 

 

Net cash provided by operating activities

     16,500        9,922   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of investment securities

     (51,924     (9,112

Proceeds from repayment and maturities from investment securities

     35,799        19,780   

Loans originated, net of principal payments

     (111,409     (84,134

Purchases of premises and equipment

     (225     (515

Proceeds from sale of OREO

     311        —     

Net decrease in certificates of deposit in other financial institutions

     2,450        13,839   

Purchase of bank owned life insurance

     —          (10,000
  

 

 

   

 

 

 

Net cash used in investing activities

     (124,998     (70,142
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase in Non-interest bearing demand deposits

     49,465        102,090   

Net (decrease) increase in Interest bearing transaction accounts

     (2,020     45,455   

Net increase in Money market and savings deposits

     68,409        47,544   

Net decrease in Certificates of deposit

     (6,902     (5,254

Net increase in Securities sold under agreements to repurchase

     11,422        5,013   

Net proceeds from stock options exercised

     3,453        1,020   

Restricted stock repurchase

     (305     (504

Dividends paid on preferred stock

     (519     (101

Net excess in tax benefit on stock compensation

     772        451   
  

 

 

   

 

 

 

Net cash provided by financing activities

     123,775        195,714   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     15,277        135,494   

Cash and cash equivalents, beginning of period

     222,063        132,586   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 237,340      $ 268,080   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these consolidated financial statements

 

Page 6 of 71


Table of Contents

CU BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

(Dollars in thousands)

 

     Six Months Ended
June 30,
 
     2016      2015  

Supplemental disclosures of cash flow information:

     

Cash paid for interest

   $ 1,574       $ 1,348   

Net cash paid for taxes

   $ 2,347       $ 4,060   

Supplemental disclosures of non-cash investing activities:

     

Net change in unrealized gain (loss) on available-for-sale investment securities, net of tax

   $ 1,594       $ (238

Loans transferred to other real estate owned

   $ —         $ 850   

 

Page 7 of 71


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CU BANCORP

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2016

(Unaudited)

Note 1 - Basis of Financial Statement Presentation

CU Bancorp (the “Company”) is a bank holding company whose operating subsidiary is California United Bank. As a bank holding company, CU Bancorp is subject to regulation of the Federal Reserve Board (“FRB”). The term “Company”, as used throughout this document, refers to the consolidated financial statements of CU Bancorp and California United Bank.

California United Bank (the “Bank”) is a full-service commercial business bank offering a broad range of banking products and services including: deposit services, lending and cash management to small and medium-sized businesses, to non-profit organizations, to business principals and entrepreneurs, to the professional community, including attorneys, certified public accountants, financial advisors, healthcare providers and investors. The Bank opened for business in 2005. Its current headquarters office is located in Los Angeles, California. As a state chartered non-member bank, the Bank is subject to regulation by the California Department of Business Oversight (“DBO”) and the Federal Deposit Insurance Corporation (“FDIC”). The deposits of the Bank are insured by the FDIC to the maximum amount allowed by law.

The consolidated financial statements include the accounts of the Company and the Bank. Significant intercompany items have been eliminated in consolidation. The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).

CU Bancorp is the common shareholder of Premier Commercial Statutory Trust I, Premier Commercial Statutory Trust II, and Premier Commercial Statutory Trust III, entities which were acquired in the merger with Premier Commercial Bancorp (“PC Bancorp”). These trusts were established for the sole purpose of issuing trust preferred securities and do not meet the criteria for consolidation. For more detail, see Note 8 – Borrowings and Subordinated Debentures.

Certain information and footnote disclosures presented in the annual consolidated financial statements are not included in the interim consolidated financial statements. Accordingly, the accompanying unaudited interim consolidated financial statements should be read in conjunction with the 2015 Annual Report on Form 10-K. In the opinion of management, the accompanying interim consolidated financial statements contain all necessary adjustments of a normal recurring nature, to present fairly the consolidated financial position of the Company and the results of its operations for the interim periods presented.

Use of Estimates in the Preparation of Consolidated Financial Statements

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In addition, these accounting principles require the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements.

Estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan loss and various assets and liabilities measured at fair value. While management uses the most current available information to recognize losses on loans, future additions to the allowance for loan loss may be necessary based on, among other factors, changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan loss. Regulatory agencies may require the Company to recognize changes to the allowance for loan loss based on their judgment about information available to them at the time of their examination.

 

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Business Segments

The Company is organized and operates as a single reporting segment, principally engaged in commercial business banking. The Company conducts its lending and deposit operations through nine full service branch offices located in Los Angeles, Orange, Ventura and San Bernardino counties.

Note 2 - Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), which replaced existing revenue recognition guidance for contracts to provide goods or services to customers and amended existing guidance related to recognition of gains and losses on the sale of certain nonfinancial assets such as real estate. ASU 2014-09 established a principles-based approach to recognizing revenue that applies to all contracts other than those covered by other authoritative GAAP guidance. Quantitative and qualitative disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows were also required. ASU 2014-09 was to be effective for interim and annual periods beginning after December 15, 2016 and was to be applied on either a modified retrospective or full retrospective basis. In August 2015, the FASB issued ASU 2015-14 which defers the original effective date for all entities by one year. Public business entities should apply the guidance in ASU 2015-14 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. Changes to the current GAAP model primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The accounting for other financial instruments, such as loans, investments in debt securities, and financial liabilities is largely unchanged. The classification and measurement guidance will be effective for public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Entities can early adopt the provision to record fair value changes for financial liabilities under the fair value option resulting from instrument-specific credit risk in other comprehensive income. Early adoption of these provisions can be elected for all financial statements of fiscal years and interim periods that have not yet been issued or that have not yet been made available for issuance. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases. The most significant change for lessees is the requirement under the new guidance to recognize right-of-use assets and lease liabilities for all leases not considered short-term leases. By definition, a short-term lease is one in which: (a) the lease term is 12 months or less and (b) there is not an option to purchase the underlying asset that the lessee is reasonably certain to exercise. For short-term leases, lessees may elect an accounting policy by class of underlying asset under which right-of-use assets and lease liabilities are not recognized and lease payments are generally recognized as expense over the lease term on a straight-line basis. This change will result in lessees recognizing right-of-use assets and lease liabilities for most leases currently accounted for as operating leases under the legacy lease accounting guidance. Examples of changes in the new guidance affecting both lessees and lessors include: (a) defining initial direct costs to only include those incremental costs that would not have been incurred if the lease had not been entered into, (b) requiring related party leases to be accounted for based on their legally enforceable terms and conditions, (c) eliminating the additional requirements that must be applied today to leases involving real estate and (d) revising the circumstances under which the transfer contract in a sale-leaseback transaction should be accounted for as the sale of an asset by the seller-lessee and the purchase of an asset by the buyer-lessor. In addition, both lessees and lessors are subject to new disclosure requirements. ASU 2016-02 is effective for public entities for interim and annual periods beginning after December 15, 2018. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, to reduce the complexity of certain aspects of the accounting for employee share-based payment transactions. As a result of this ASU, changes applicable to all entities include: 1) The threshold to qualify for equity classification would permit withholding up to the maximum individual statutory tax rate in the applicable jurisdictions. Also, the ASU provides that cash paid by an employer when directly withholding shares for tax-withholding purposes would be classified as a financing activity on the statement of cash flows; 2) An entity would be allowed to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur; 3) All excess tax benefits and tax deficiencies would be recognized as income tax expense or

 

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benefit in the income statement. An entity also would recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Further, excess tax benefits would not be separated from other income tax cash flows and thus would be classified along with other cash flows as an operating activity. ASU 2016-09 is effective for public entities for interim and annual periods beginning after December 15, 2016. The Company does not expect a material impact of this ASU on its consolidated financial statements.

On June 16, 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which introduces new guidance for the accounting for credit losses on instruments within its scope. The new guidance introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale (AFS) debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. Current expected credit losses (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes loans, held-to-maturity debt securities, loan commitments, financial guarantees, and net investments in leases, as well as reinsurance and trade receivables. Upon initial recognition of the exposure, the CECL model requires an entity to estimate the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses (ECL) should consider historical information, current information, and reasonable and supportable forecasts, including estimates of prepayments. Financial instruments with similar risk characteristics should be grouped together when estimating ECL. ASU 2016-13 is effective for public entities for interim and annual periods beginning after December 15, 2019. Early application of the guidance will be permitted for all entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of this ASU on its consolidated financial statements.

 

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Note 3 - Computation of Book Value and Tangible Book Value per Common Share

Book value per common share was calculated by dividing total shareholders’ equity less preferred stock, by the number of common shares issued and outstanding. Tangible book value per common share was calculated by dividing tangible common equity, by the number of common shares issued and outstanding. The tables below present the computation of book value and tangible book value per common share as of the dates indicated (dollars in thousands, except share and per share data):

 

     June 30,
2016
     December 31,
2015
 

Total Shareholders’ Equity

   $ 326,459       $ 306,807   

Less: Preferred stock

     17,086         16,995   

Less: Goodwill

     64,603         64,603   

Less: Core deposit and leasehold right intangibles, net

     6,932         7,671   
  

 

 

    

 

 

 

Tangible common equity

   $ 237,838       $ 217,538   
  

 

 

    

 

 

 

Common shares issued and outstanding

     17,668,381         17,175,389   

Book value per common share

   $ 17.51       $ 16.87   
  

 

 

    

 

 

 

Tangible book value per common share

   $ 13.46       $ 12.67   
  

 

 

    

 

 

 

Note 4 - Computation of Earnings per Common Share

Basic and diluted earnings per common share were determined by dividing net income available to common shareholders by the applicable basic and diluted weighted average common shares outstanding. The following table shows weighted average basic common shares outstanding, potential dilutive shares related to stock options, unvested restricted stock, and weighted average diluted shares for the periods indicated (dollars in thousands, except share and per share data):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2016      2015      2016      2015  

Net Income

   $ 6,645       $ 5,267       $ 12,932       $ 9,466   

Less: Preferred stock dividends and discount accretion

     307         312         610         584   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income available to common shareholders

   $ 6,338       $ 4,955       $ 12,322       $ 8,882   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average basic common shares outstanding

     17,210,433         16,481,527         17,125,930         16,445,118   

Dilutive effect of potential common share issuances from stock options and restricted stock

     250,774         442,684         274,960         441,102   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average diluted common shares outstanding

     17,461,207         16,924,211         17,400,890         16,886,220   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income per common share

           

Basic

   $ 0.37       $ 0.30       $ 0.72       $ 0.54   

Diluted

   $ 0.36       $ 0.29       $ 0.71       $ 0.53   

Anti-dilutive shares not included in the calculation of diluted earnings per share

     —           64,500         1,500         64,889   

 

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Note 5 - Investment Securities

The investment securities portfolio has been classified into two categories: available-for-sale (“AFS”) and held-to-maturity (“HTM”).

The following tables present the amortized cost, gross unrealized gains and losses, and fair values of investment securities by major category as of the dates indicated (dollars in thousands):

 

            Gross Unrealized         

June 30, 2016

   Amortized
Cost
     Gains      Losses      Fair Market
Value
 

Available-for-sale:

           

U.S. Govt Agency and Sponsored Agency - Note Securities

   $ 1,006       $ 2       $ —         $ 1,008   

U.S. Govt Agency - SBA Securities

     94,655         616         308         94,963   

U.S. Govt Agency - GNMA Mortgage-Backed Securities

     27,416         191         100         27,507   

U.S. Govt Sponsored Agency - CMO & Mortgage-Backed Securities

     130,708         1,305         208         131,805   

Corporate Securities

     506         1         —           507   

Asset Backed Securities

     7,498         —           282         7,216   

U.S. Treasury Notes

     70,981         126         —           71,107   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale

     332,770         2,241         898         334,113   

Held-to-maturity:

           

Municipal Securities

     40,595         855         —           41,450   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held-to-maturity

     40,595         855         —           41,450   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 373,365       $ 3,096       $ 898       $ 375,563   
  

 

 

    

 

 

    

 

 

    

 

 

 
            Gross Unrealized         

December 31, 2015

   Amortized
Cost
     Gains      Losses      Fair Market
Value
 

Available-for-sale:

           

U.S. Govt Agency and Sponsored Agency - Note Securities

   $ 1,014       $ —         $ —         $ 1,014   

U.S. Govt Agency - SBA Securities

     93,674         399         583         93,490   

U.S. Govt Agency - GNMA Mortgage-Backed Securities

     30,916         202         418         30,700   

U.S. Govt Sponsored Agency - CMO & Mortgage-Backed Securities

     97,693         250         789         97,154   

Corporate Securities

     4,016         7         —           4,023   

Municipal Securities

     1,010         1         —           1,011   

Asset Backed Securities

     7,890         —           243         7,647   

U.S. Treasury Notes

     80,981         —           235         80,746   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale

     317,194         859         2,268         315,785   

Held-to-maturity:

           

Municipal Securities

     42,036         335         32         42,339   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total held-to-maturity

     42,036         335         32         42,339   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 359,230       $ 1,194       $ 2,300       $ 358,124   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The Company’s investment securities portfolio at June 30, 2016 consists of A-rated or above investment-grade securities. At June 30, 2016 and December 31, 2015, securities with a market value of $194 million and $197 million, respectively, were pledged as collateral for securities sold under agreements to repurchase, public deposits, outstanding standby letters of credit, bankruptcy deposits, and other purposes as required by various statutes and agreements. See Note 8 – Borrowings and Subordinated Debentures.

The following tables present the gross unrealized losses and fair values of AFS and HTM investment securities that were in unrealized loss positions, summarized and classified according to the duration of the loss period as of the dates indicated (dollars in thousands).

 

     < 12 Continuous
Months
     > 12 Continuous
Months
     Total  

June 30, 2016

   Fair
Value
     Gross
Unrealized
Loss
     Fair
Value
     Gross
Unrealized
Loss
     Fair
Value
     Gross
Unrealized
Loss
 

Available-for-sale investment securities:

                 

U.S. Govt. Agency SBA Securities

   $ 40,936       $ 264       $ 5,224       $ 44       $ 46,160       $ 308   

U.S. Govt. Agency – GNMA Mortgage-Backed Securities

     6,384         22         10,496         78         16,880         100   

U.S. Govt. Sponsored Agency – CMO & Mortgage-Backed Securities

     15,004         75         14,240         133         29,244         208   

Asset Backed Securities

     —           —           7,216         282         7,216         282   

U.S Treasury Notes

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale investment securities

   $ 62,324       $ 361       $ 37,176       $ 537       $ 99,500       $ 898   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     < 12 Continuous
Months
     > 12 Continuous
Months
     Total  

December 31, 2015

   Fair
Value
     Gross
Unrealized
Loss
     Fair
Value
     Gross
Unrealized
Loss
     Fair
Value
     Gross
Unrealized
Loss
 

Available-for-sale investment securities:

                 

U.S. Govt. Agency SBA Securities

   $ 53,852       $ 428       $ 7,935       $ 154       $ 61,787       $ 582   

U.S. Govt. Agency – GNMA Mortgage-Backed Securities

     5,417         47         14,296         371         19,713         418   

U.S. Govt. Sponsored Agency – CMO & Mortgage-Backed Securities

     67,475         564         10,024         225         77,499         789   

Asset Backed Securities

     2,928         54         4,719         190         7,647         244   

U.S Treasury Notes

     80,745         235         —           —           80,745         235   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale investment securities

   $ 210,417       $ 1,328       $ 36,974       $ 940       $ 247,391       $ 2,268   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Held-to-maturity investment securities:

                 

Municipal Securities

   $ 5,669       $ 16       $ 2,392       $ 16       $ 8,061       $ 32   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total held-to-maturity investment securities

   $ 5,669       $ 16       $ 2,392       $ 16       $ 8,061       $ 32   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The unrealized losses in each of the above categories are associated with the general fluctuation of market interest rates and are not an indication of any deterioration in the credit quality of the security issuers. Further, the Company does not intend to sell these securities and is not more-likely-than-not to be required to sell the securities before the recovery of its amortized cost basis. Accordingly, the Company had no securities that were classified as other-than-temporarily impaired at June 30, 2016 or December 31, 2015, and did not recognize any impairment charges in the consolidated statements of income.

 

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The amortized cost, fair value and the weighted average yield of debt securities at June 30, 2016, are reflected in the table below (dollars in thousands). Maturity categories are determined as follows:

 

    U.S. Govt. Agency, U.S. Treasury Notes and U.S. Govt. Sponsored Agency bonds and notes – maturity date

 

    U.S. Govt. Sponsored Agency CMO or Mortgage-Backed Securities, U.S. Govt. Agency GNMA Mortgage-Backed Securities, Asset Backed Securities and U.S. Gov. Agency SBA Securities – estimated cash flow taking into account estimated pre-payment speeds

 

    Investment grade Corporate Bonds and Municipal Securities – the earlier of the maturity date or the expected call date

Although, U.S. Government Agency and U.S. Government Sponsored Agency Mortgage-Backed and CMO securities have contractual maturities through 2048, the expected maturity will differ from the contractual maturities because borrowers or issuers may have the right to prepay such obligations without penalties.

 

     June 30, 2016  

Maturities Schedule of Securities (Dollars in thousands)

   Amortized
Cost
     Fair Value      Weighted
Average
Yield
 

Available-for-sale:

        

Due through one year

   $ 82,217       $ 82,409         1.20

Due after one year through five years

     146,221         146,553         1.45

Due after five years through ten years

     75,381         75,909         1.99

Due after ten years

     28,951         29,242         2.52
  

 

 

    

 

 

    

 

 

 

Total available-for-sale

   $ 332,770       $ 334,113         1.60

Held-to-maturity:

        

Due through one year

   $ 2,912       $ 2,926         1.53

Due after one year through five years

     33,817         34,494         1.55

Due after five years through ten years

     3,866         4,030         1.93
  

 

 

    

 

 

    

 

 

 

Total held-to-maturity

   $ 40,595       $ 41,450         1.59
  

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 373,365       $ 375,563         1.60
  

 

 

    

 

 

    

 

 

 

The weighted average yields in the above table are based on effective rates of net book balances at the end of the period.

Investment in Federal Home Loan Bank (FHLB) Common Stock

The Company’s investment in the common stock of the FHLB of San Francisco is carried at cost and was $9.2 million at June 30, 2016 and $8.0 million at December 31, 2015. The investment in FHLB stock is included in accrued interest receivable and other assets in the consolidated balance sheets and is periodically evaluated for impairment. Based on the capital adequacy of the FHLB and its overall financial condition, no impairment losses have been recorded.

See Note 8 - Borrowings and Subordinated Debentures for a detailed discussion regarding the Company’s borrowings and the requirements to purchase FHLB common stock. See Note 5 - Investment Securities in the Company’s Form 10-K for the year ended December 31, 2015 for additional discussion on the Company’s evaluation and accounting for its investment in FHLB common stock.

 

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Note 6 - Loans

The following table presents the composition of the Company’s loan portfolio as of the dates indicated (dollars in thousands):

 

     June 30,
2016
     December 31,
2015
 

Commercial and Industrial Loans:

   $ 522,074       $ 537,368   

Loans Secured by Real Estate:

     

Owner-Occupied Nonresidential Properties

     425,515         407,979   

Other Nonresidential Properties

     582,204         533,168   

Construction, Land Development and Other Land

     165,963         125,832   

1-4 Family Residential Properties

     121,971         114,525   

Multifamily Residential Properties

     86,942         71,179   
  

 

 

    

 

 

 

Total Loans Secured by Real Estate

     1,382,595         1,252,683   
  

 

 

    

 

 

 

Other Loans:

     46,442         43,112   
  

 

 

    

 

 

 

Total Loans

   $ 1,951,111       $ 1,833,163   
  

 

 

    

 

 

 

Loan balances in the table above include net deferred fees and net discounts for a total of $18 million and $22 million as of June 30, 2016 and December 31, 2015, respectively.

Small Business Administration Loans

Included in the loan portfolio is $32 million in loans that were originated under the guidelines of the Small Business Administration (“SBA”) program of which $6 million is guaranteed. The total portfolio of the SBA contractual loan balances serviced by the Company at June 30, 2016 was $113 million, of which $81 million has been sold.

At June 30, 2016, there were no loans classified as held for sale. At June 30, 2016, the balance of SBA 7a loans originated during the quarter is $728 thousand, of which $546 thousand is guaranteed by the SBA. The Company does not currently plan on selling these loans, but it may choose to do so in the future.

 

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Allowance for Loan Loss

The following table is a summary of the activity for the allowance for loan loss for the periods indicated (dollars in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2016     2015     2016     2015  

Allowance for loan loss at beginning of period

   $ 16,545      $ 13,247      $ 15,682      $ 12,610   

Provision for loan losses

     1,063        683        1,685        2,126   

Net (charge-offs) recoveries:

        

Charge-offs

     (20     (1     (20     (891

Recoveries

     888        195        1,129        279   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     868        194        1,109        (612
  

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan loss at end of period

   $ 18,476      $ 14,124      $ 18,476      $ 14,124   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries to average loans

     0.05     0.01     0.06     (0.04 )% 

 

     June 30,
2016
    December 31,
2015
 

Allowance for loan loss to total loans

     0.95     0.82

Allowance for loan loss to total loans accounted for at historical cost, which excludes loans and the related allowance for loans acquired through acquisition

     1.22     1.33

 

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The following tables present, by portfolio segment, the changes in the allowance for loan loss and the recorded investment in loans as of the dates and for the periods indicated (dollars in thousands):

 

     Commercial
and
Industrial
    Construction,
Land
Development
and

Other Land
    Commercial
and

Other
Real Estate
    Other     Total  

Three Months Ended June 30, 2016

          

Allowance for loan loss – Beginning balance

   $ 6,725      $ 2,711      $ 6,374      $ 735      $ 16,545   

Provision for loan losses

     789        13        192        69        1,063   

Net (charge-offs) recoveries:

          

Charge-offs

     (20     —          —          —          (20

Recoveries

     887        —          1        —          888   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net recoveries

     867        —          1        —          868   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 8,381      $ 2,724      $ 6,567      $ 804      $ 18,476   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended June 30, 2015

          

Allowance for loan loss – Beginning balance

   $ 5,737      $ 1,763      $ 5,439      $ 308      $ 13,247   

Provision for loan losses

     314        (156     359        166        683   

Net (charge-offs) recoveries:

          

Charge-offs

     (1     —          —          —          (1

Recoveries

     194        —          1        —          195   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net recoveries

     193        —          1        —          194   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 6,244      $ 1,607      $ 5,799      $ 474      $ 14,124   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     Commercial
and
Industrial
    Construction,
Land
Development
and

Other Land
    Commercial
and

Other
Real Estate
    Other     Total  

Six Months Ended June 30, 2016

          

Allowance for loan loss – Beginning balance

   $ 5,924      $ 2,076      $ 6,821      $ 861      $ 15,682   

Provision for loan losses

     1,350        648        (256     (57     1,685   

Net (charge-offs) recoveries:

          

Charge-offs

     (20     —          —          —          (20

Recoveries

     1,127        —          2        —          1,129   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net recoveries

     1,107        —          2        —          1,109   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 8,381      $ 2,724      $ 6,567      $ 804      $ 18,476   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended June 30, 2015

          

Allowance for loan loss – Beginning balance

   $ 5,864      $ 1,684      $ 4,802      $ 260      $ 12,610   

Provision for loan losses

     995        (77     994        214        2,126   

Net (charge-offs) recoveries:

          

Charge-offs

     (891     —          —          —          (891

Recoveries

     276        —          3        —          279   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     (615     —          3        —          (612
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 6,244      $ 1,607      $ 5,799      $ 474      $ 14,124   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Page 17 of 71


Table of Contents

The following tables present both the allowance for loan loss and the associated loan balance classified by loan portfolio segment and by credit evaluation methodology (dollars in thousands):

 

     Commercial
and
Industrial
     Construction,
Land
Development
and

Other Land
     Commercial
and

Other
Real Estate
     Other      Total  

June 30, 2016

              

Allowance for loan loss:

              

Individually evaluated for impairment

   $ 641       $ —         $ —         $ —         $ 641   

Collectively evaluated for impairment

     7,740         2,724         6,567         804         17,835   

Purchased credit impaired (loans acquired with deteriorated credit quality)

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Allowance for Loan Loss

   $ 8,381       $ 2,724       $ 6,567       $ 804       $ 18,476   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans receivable:

              

Individually evaluated for impairment

   $ 1,647       $ —         $ 256       $ —         $ 1,903   

Collectively evaluated for impairment

     520,093         165,963         1,214,847         46,442         1,947,345   

Purchased credit impaired (loans acquired with deteriorated credit quality)

     334         —           1,529         —           1,863   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans Receivable

   $ 522,074       $ 165,963       $ 1,216,632       $ 46,442       $ 1,951,111   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Commercial
and
Industrial
     Construction,
Land
Development
and

Other Land
     Commercial
and

Other
Real Estate
     Other      Total  

December 31, 2015

              

Allowance for loan loss:

              

Individually evaluated for impairment

   $ —         $ —         $ —         $ —         $ —     

Collectively evaluated for impairment

     5,924         2,076         6,821         861         15,682   

Purchased credit impaired (loans acquired with deteriorated credit quality)

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Allowance for Loan Loss

   $ 5,924       $ 2,076       $ 6,821       $ 861       $ 15,682   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loans receivable:

              

Individually evaluated for impairment

   $ 558       $ —         $ 649       $ —         $ 1,207   

Collectively evaluated for impairment

     536,333         125,832         1,124,667         43,112         1,829,944   

Purchased credit impaired (loans acquired with deteriorated credit quality)

     477         —           1,535         —           2,012   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Loans Receivable

   $ 537,368       $ 125,832       $ 1,126,851       $ 43,112       $ 1,833,163   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Page 18 of 71


Table of Contents

Credit Quality of Loans

The Company utilizes an internal loan classification system as a means of reporting problem and potential problem loans. Under the Company’s loan risk rating system, loans are classified as “Pass,” with problem and potential problem loans as “Special Mention,” “Substandard,” “Doubtful” and “Loss”. Individual loan risk ratings are updated continuously or at any time the situation warrants. In addition, management regularly reviews problem loans to determine whether any loan requires a classification change, in accordance with the Company’s policy and applicable regulations. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The internal loan classification risk grading system is based on experiences with similarly graded loans.

The Company’s internally assigned grades are as follows:

 

    Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. There are several different levels of Pass rated credits, including “Watch” which is considered a transitory grade for pass rated loans that require greater monitoring. Loans not meeting the criteria of special mention, substandard, doubtful or loss that have been analyzed individually as part of the above described process are considered to be pass-rated loans.

 

    Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected. Special Mention loans do not currently expose the Company to sufficient risk to warrant classification as a Substandard, Doubtful or Loss classification, but possess weaknesses that deserve management’s close attention.

 

    Substandard – loans that have a well-defined weakness based on objective evidence and can be characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

 

    Doubtful – loans classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 

    Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted.

The following tables present the risk category of loans by class of loans based on the most recent internal loan classification as of the dates indicated (dollars in thousands):

 

     Commercial and
Industrial
     Construction,
Land
Development
and

Other Land
     Commercial and
Other
Real Estate
     Other      Total  

June 30, 2016

              

Pass

   $ 460,117       $ 165,963       $ 1,190,670       $ 43,504       $ 1,860,254   

Special Mention

     17,621         —           4,001         —           21,622   

Substandard

     44,336         —           21,961         2,938         69,235   

Doubtful

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 522,074       $ 165,963       $ 1,216,632       $ 46,442       $ 1,951,111   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2015

              

Pass

   $ 503,006       $ 125,832       $ 1,101,548       $ 40,132       $ 1,770,518   

Special Mention

     16,041         —           6,494         43         22,578   

Substandard

     18,321         —           18,809         2,937         40,067   

Doubtful

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 537,368       $ 125,832       $ 1,126,851       $ 43,112       $ 1,833,163   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Page 19 of 71


Table of Contents

Aging Analysis of Past Due and Non-Accrual Loans

The following tables present an aging analysis of the recorded investment of past due loans and non-accrual loans as of the dates indicated (dollars in thousands):

 

     31-60
Days
Past Due
     61-90
Days
Past Due
     Greater
than
90 Days
Past Due
and
Accruing
     Total
Past Due
and
Accruing
     Total
Non
Accrual
     Current      Total Loans  

June 30, 2016

                    

Commercial and Industrial

   $ 131       $ 7       $ —         $ 138       $ 1,979       $ 519,957       $ 522,074   

Construction, Land Development and Other Land

     —           —           —           —           —           165,963         165,963   

Commercial and Other Real Estate

     —           —           —           —           598         1,216,034         1,216,632   

Other

     —           —           —           —           —           46,442         46,442   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 131       $ 7       $ —         $ 138       $ 2,577       $ 1,948,396       $ 1,951,111   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     31-60
Days
Past Due
     61-90
Days
Past Due
     Greater
than
90 Days
Past Due
and
Accruing
     Total
Past Due
and
Accruing
     Total
Non
Accrual
     Current      Total Loans  

December 31, 2015

                    

Commercial and Industrial

   $ —         $ —         $ —         $ —         $ 1,032       $ 536,336       $ 537,368   

Construction, Land Development and Other Land

     —           —           —           —           —           125,832         125,832   

Commercial and Other Real Estate

     —           —           —           —           1,019         1,125,832         1,126,851   

Other

     —           —           —           —           —           43,112         43,112   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ —         $ —         $ —         $ 2,051       $ 1,831,112       $ 1,833,163   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Page 20 of 71


Table of Contents

Impaired Loans

Impaired loans are evaluated by comparing the fair value of the collateral, if the loan is collateral dependent, and the present value of the expected future cash flows discounted at the loan’s effective interest rate, if the loan is not collateral dependent.

A valuation allowance is established for an impaired loan when the realizable value of the loan is less than the recorded investment. In certain cases, portions of impaired loans are charged-off to realizable value instead of establishing a valuation allowance and are included, when applicable, in the table below as impaired loans “with no specific allowance recorded.” The valuation allowance disclosed below is included in the allowance for loan loss reported in the consolidated balance sheets as of June 30, 2016 and December 31, 2015.

The following tables present, by loan portfolio segment, the recorded investment and unpaid principal balances for impaired loans with the associated allowance amount, if applicable, for the dates and periods indicated (dollars in thousands). This table excludes purchased credit impaired loans (loans acquired in acquisitions with deteriorated credit quality) of $1.9 million and $2.0 million at June 30, 2016 and December 31, 2015, respectively.

 

     June 30, 2016      December 31, 2015  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

With no specific allowance recorded:

                 

Commercial and Industrial

   $ 700       $ 1,106       $ —         $ 558       $ 1,027       $ —     

Commercial and Other Real Estate

     256         289         —           649         692         —     

With an allowance recorded:

                 

Commercial and Industrial

     947         990         641         —           —           —     

Total

                 

Commercial and Industrial

     1,647         2,096         641         558         1,027         —     

Commercial and Other Real Estate

     256         289         —           649         692         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,903       $ 2,385       $ 641       $ 1,207       $ 1,719       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2016     2015     2016     2015  
    Average
Recorded
Investment
    Interest
Income
Recognized
    Average
Recorded
Investment
    Interest
Income
Recognized
    Average
Recorded
Investment
    Interest
Income
Recognized
    Average
Recorded
Investment
    Interest
Income
Recognized
 

With no specific allowance recorded:

               

Commercial and Industrial

  $ 545      $ —        $ 2,053      $ —        $ 400      $ —        $ 1,562      $ —     

Commercial and Other Real Estate

    256        —          103        —          461        —          106        —     

With a specific allowance recorded:

               

Commercial and Industrial

    316        —          1,357        —          158        —          1,342        —     

Commercial and Other Real Estate

    —          —          619        —          —          —          619        —     

Total:

               

Commercial and Industrial

    861        —          3,410        —          558        —          2,904        —     

Commercial and Other Real Estate

    256        —          722        —          461        —          725        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,117      $ —        $ 4,132      $ —        $ 1,019      $ —        $ 3,629      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Page 21 of 71


Table of Contents

The following is a summary of additional information pertaining to impaired loans for the periods indicated (dollars in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2016      2015      2016      2015  

Interest foregone on impaired loans

   $ 22       $ 88       $ 46       $ 138   

Cash collections applied to reduce principal balance

   $ 28       $ 19       $ 52       $ 19   

Interest income recognized on cash collections

   $ —         $ —         $ —         $ —     

Troubled Debt Restructuring

The Company’s loan portfolio contains certain loans that have been modified in a Troubled Debt Restructuring (“TDR”), where economic concessions have been granted to borrowers experiencing financial difficulties. Loans are restructured in an effort to maximize collections. Economic concessions can include: reductions to the stated interest rate, payment extensions, principal forgiveness or other actions.

The modification process includes evaluation of impairment based on the present value of expected future cash flows, discounted at the effective interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the loan collateral. In these cases, management uses the current fair value of the collateral, less selling costs, to evaluate the loan for impairment. If management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs and unamortized premium or discount) impairment is recognized through a specific allowance or a charge-off.

The following tables include the recorded investment and unpaid principal balances for troubled debt restructured loans at June 30, 2016 and December 31, 2015 (dollars in thousands). These tables include TDR loans that were purchased credit impaired (“PCI”). TDR loans that are non-PCI loans are included in the Impaired Loans tables above. As of June 30, 2016, there were two PCI loans that are considered to be TDR loans with a recorded investment of $127 thousand and unpaid principal balances of $301 thousand.

 

     As of and for the
Three Months Ended
June 30, 2016
     As of and for the
Six Months Ended
June 30, 2016
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Interest
Income
Recognized
     Recorded
Investment
     Unpaid
Principal
Balance
     Interest
Income

Recognized
 

Commercial and Industrial

   $ 377       $ 591       $ —         $ 377       $ 591       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 377       $ 591       $ —         $ 377       $ 591       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     As of and for the
Three Months Ended
June 30, 2015
     As of and for the
Six Months Ended
June 30, 2015
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Interest
Income
Recognized
     Recorded
Investment
     Unpaid
Principal
Balance
     Interest
Income
Recognized
 

Commercial and Industrial

   $ 474       $ 678       $ —         $ 474       $ 678       $ —     

Commercial and Other Real Estate

     103         107         —           103         107         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 577       $ 785       $ —         $ 577       $ 785       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Page 22 of 71


Table of Contents
     As of and for the
Twelve Months Ended
December 31, 2015
 
     Recorded
Investment
     Unpaid
Principal
Balance
     Interest
Income
Recognized
 

Commercial and Industrial

   $ 627       $ 1,363       $ —     
  

 

 

    

 

 

    

 

 

 

Total

   $ 627       $ 1,363       $ —     
  

 

 

    

 

 

    

 

 

 

There were no loans modified or restructured during the three or six months ended June 30, 2016 or June 30, 2015.

There have been no payment defaults in the three or six months ended June 30, 2016 or June 30, 2015 subsequent to modification on troubled debt restructured loans that have been modified within the last twelve months.

Loans are restructured in an effort to maximize collections. Impairment analyses are performed on the Company’s troubled debt restructured loans in conjunction with the normal allowance for loan loss process. The Company’s troubled debt restructured loans are analyzed to ensure adequate cash flow or collateral supports the outstanding loan balance.

There were no commitments to lend additional funds to borrowers whose terms have been modified in troubled debt restructurings at June 30, 2016 or December 31, 2015.

Loans Acquired Through Acquisition

The following table reflects the accretable net discount for acquired loans for the periods indicated (dollars in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2016      2015      2016      2015  

Balance, beginning of period

   $ 13,470       $ 20,078       $ 14,610       $ 21,402   

Accretion, included in interest income

     (1,517      (1,461      (2,650      (2,677

Reclassifications to non-accretable yield

     (25      (362      (32      (470
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

   $ 11,928       $ 18,255       $ 11,928       $ 18,255   
  

 

 

    

 

 

    

 

 

    

 

 

 

The above table reflects the fair value adjustment on the loans acquired from mergers that will be amortized to loan interest income based on the effective yield method over the remaining life of the loans. These amounts do not include the fair value adjustments on the purchased credit impaired loans acquired from mergers.

Purchased Credit Impaired Loans

PCI loans are acquired loans with evidence of deterioration of credit quality since origination and it is probable at the acquisition date, that the Company will not be able to collect all contractually required amounts.

When the timing and/or amounts of expected cash flows on such loans are not reasonably estimable, no interest is accreted and the loan is reported as a non-accrual loan; otherwise, if the timing and amounts of expected cash flows for PCI loans are reasonably estimable, then interest is accreted and the loans are reported as accruing loans.

The non-accretable difference represents the difference between the undiscounted contractual cash flows and the undiscounted expected cash flows, and also reflects the estimated credit losses in the acquired loan portfolio at the acquisition date and can fluctuate due to changes in expected cash flows during the life of the PCI loans.

 

Page 23 of 71


Table of Contents

The following table reflects the outstanding balance and related carrying value of PCI loans as of the dates indicated (dollars in thousands):

 

     June 30, 2016      December 31, 2015  
     Unpaid Principal
Balance
     Carrying
Value
     Unpaid Principal
Balance
     Carrying
Value
 

Commercial and Industrial

   $ 657       $ 334       $ 2,331       $ 477   

Commercial and Other Real Estate

     2,216         1,529         2,250         1,535   

Other

     —           —           61         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,873       $ 1,863       $ 4,642       $ 2,012   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table reflects the activities in the accretable net discount for PCI loans for the period indicated (dollars in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2016      2015      2016      2015  

Balance, beginning of period

   $ 226       $ 305       $ 246       $ 324   

Accretion, included in interest income

     (21      (19      (41      (38

Reclassifications from non-accretable yield

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

   $ 205       $ 286       $ 205       $ 286   
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 7 – Qualified Affordable Housing Project Investments

The Company’s investment in Qualified Affordable Housing Projects that generate Low Income Housing Tax Credits (“LIHTC”) was $3.5 million at June 30, 2016 and $3.7 million at December 31, 2015. The funding liability for the LIHTC at June 30, 2016 was $702 thousand compared to $1.1 million at December 31, 2015. The amount of tax credits and other tax benefits recognized was $143 thousand and $287 thousand for the three and six months ended June 30, 2016 and $145 thousand and $290 thousand for the three and six months ended June 30, 2015, respectively. Further, the amount of amortization expense included in the provision for income taxes was $112 thousand and $224 thousand for the three and six months ended June 30, 2016 and $114 thousand and $229 thousand for the three and six months ended June 30, 2015, respectively. These investments and related tax credits are described more fully in Note 11 – Qualified Affordable Housing Project Investments in the Company’s Form 10-K for the year ended December 31, 2015.

 

Page 24 of 71


Table of Contents

Note 8 - Borrowings and Subordinated Debentures

Securities Sold Under Agreements to Repurchase

The Company enters into certain transactions, the legal form of which are sales of securities under agreements to repurchase (“Repos”) at a later date at a set price. Securities sold under agreements to repurchase generally mature within 1 day to 180 days from the issue date and are routinely renewed.

As discussed in Note 5 – Investment Securities, the Company has pledged certain investments as collateral for these agreements. Securities with a fair value of $58 million and $47 million were pledged to secure the Repos at June 30, 2016 and December 31, 2015, respectively.

The tables below describe the terms and maturity of the Company’s securities sold under agreements to repurchase as of the dates indicated (dollars in thousands):

 

     June 30, 2016  

Date Issued

   Amount      Interest Rate     Original
Term
     Maturity Date  

June 30, 2016

   $ 25,782         0.11% – 0.25     1 day         July 1, 2016   
  

 

 

         

Total

   $ 25,782         0.23     
  

 

 

         
     December 31, 2015  

Date Issued

   Amount      Interest Rate     Original
Term
     Maturity Date  

December 31, 2015

   $ 14,360         0.08% – 0.25     4 days         January 4, 2016   
  

 

 

         

Total

   $ 14,360         0.19     
  

 

 

         

FHLB Borrowings

The Company maintains a secured credit facility with the FHLB, allowing the Company to borrow on an overnight and term basis. The Company’s credit facility with the FHLB is $685 million, which represents approximately 25% of the Bank’s total assets, as reported by the Bank in its March 31, 2015 Federal Financial Institution Examination Council (FFIEC) Call Report.

As of June 30, 2016, the Company had $917 million of loan collateral pledged with the FHLB which provides $608 million in borrowing capacity. The Company has $18 million in investment securities pledged with the FHLB to support this credit facility. In addition, the Company must maintain an investment in the capital stock of the FHLB. Under the FHLB Act, the FHLB has a statutory lien on the FHLB capital stock that the Company owns and the FHLB capital stock serves as further collateral under the borrowing line.

The Company had no outstanding advances (borrowings) with the FHLB as of June 30, 2016 or December 31, 2015.

Subordinated Debentures

The following table summarizes the terms of each issuance of subordinated debentures outstanding as of June 30, 2016:

 

Series

   Amount
(in thousands)
    Issuance
Date
     Maturity
Date
     Rate Index     Current
Rate
    Next Reset
Date
 

Trust I

   $ 6,186        12/10/04         03/15/35         3 month LIBOR + 2.05%        2.703     09/15/16   

Trust II

     3,093        12/23/05         03/15/36         3 month LIBOR + 1.75%        2.403     09/15/16   

Trust III

     3,093        06/30/06         09/18/36         3 month LIBOR + 1.85%        2.503     09/15/16   
  

 

 

             

Subtotal

     12,372               

Unamortized fair value adjustment

     (2,595            
  

 

 

             

Net

   $ 9,777               
  

 

 

             

 

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The Company had an aggregate outstanding contractual balance of $12.4 million in subordinated debentures at June 30, 2016. These subordinated debentures were acquired as part of the PC Bancorp merger and were issued to trusts originally established by PC Bancorp, which in turn issued trust preferred securities. These subordinated debentures were issued in three separate series. Each issuance had a maturity of 30 years from their approximate date of issue. All three subordinated debentures are variable rate instruments that reprice quarterly based on the three month London Interbank Offered Rate (“LIBOR”) plus a margin (see tables above). All three subordinated debentures had their interest rates reset in June 2016 at the current three month LIBOR plus their index, and will continue to reprice quarterly through their maturity date. All three subordinated debentures are currently callable at par with no prepayment penalties.

Under Dodd Frank, trust preferred securities are excluded from Tier 1 capital, unless such securities were issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets. CU Bancorp assumed approximately $12.4 million of junior subordinated debt securities issued to various business trust subsidiaries of PC Bancorp and funded through the issuance of approximately $12.0 million of floating rate capital trust preferred securities. These junior subordinated debt securities were issued prior to May 19, 2010. Because CU Bancorp has less than $15 billion in assets, the trust preferred securities that CU Bancorp assumed from PC Bancorp continue to be included in Tier 1 capital, subject to a limit of 25% of Tier 1 capital elements.

Interest payments made by the Company on subordinated debentures are considered dividend payments under FRB regulations. Notification to the FRB is required prior to the Company declaring and paying a dividend during any period in which the Company’s quarterly net earnings are insufficient to fund the dividend amount. This notification requirement is included in regulatory guidance regarding safety and soundness surrounding capital and includes other non-financial measures such as asset quality, financial condition, capital adequacy, liquidity, future earnings projections, capital planning and credit concentrations. Should the FRB object to the dividend payments, the Company would be precluded from paying interest on the subordinated debentures after giving notice within 15 days before the payment date. Payments would not commence until approval is received or the Company no longer needs to provide notice under applicable guidance. The Company has the right, assuming no default has occurred, to defer payments of interest on the subordinated debentures at any time for a period not to exceed 20 consecutive quarters. The Company has not deferred any interest payments.

Note 9 - Derivative Financial Instruments

The Company is exposed to certain risks relating to its ongoing business operations and utilizes interest rate swap agreements (“swaps”) as part of its asset/liability management strategy to help manage its interest rate risk position. The Company has two counterparty banks.

Derivative Financial Instruments Acquired from 1st Enterprise Bank

At June 30, 2016, the Company has twelve interest rate swap agreements with customers and twelve offsetting interest-rate swaps with a counterparty bank. The swap agreements are not designated as hedging instruments. The purpose of entering into offsetting derivatives not designated as a hedging instrument is to provide the Company a variable-rate loan receivable and provide the customer the financial effects of a fixed-rate loan without creating significant interest rate risk in the Company’s earnings.

The structure of the swaps is as follows: The Company enters into a swap with its customers to allow them to convert variable rate loans to fixed rate loans, and at the same time, the Company enters into a swap with the counterparty bank to allow the Company to pass on the interest-rate risk associated with fixed rate loans. The net effect of the transaction allows the Company to receive interest on the loan from the customer at a variable rate based on LIBOR plus a spread. The changes in the fair value of the swaps primarily offset each other and therefore should not have a significant impact on the Company’s results of operations. The interest rate swap derivatives acquired from 1st Enterprise Bank are subject to a master netting arrangement with one counterparty bank. None of the derivative assets and liabilities are offset in the balance sheet.

The Company believes the risk of loss associated with counterparty borrowers relating to interest rate swaps is mitigated as the loans with swaps are underwritten to take into account potential additional exposure, although there can be no assurances in this regard since the performance of the swaps is subject to market and counterparty risk. At June 30, 2016 and December 31, 2015, the total notional amount of the Company’s swaps with the counterparty bank was $27 million and $28 million, respectively.

 

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The following tables present the fair values of the asset and liability of the Company’s derivative instruments acquired from 1st Enterprise Bank as of the dates and periods indicated (dollars in thousands):

 

     June 30,
2016
     December 31,
2015
 

Interest rate swap contracts fair value

   $ 1,721       $ 881   
  

 

 

    

 

 

 

Balance sheet location

    
 
 
Accrued Interest
Receivable and Other
Assets
  
  
  
    
 
 
Accrued Interest
Receivable and Other
Assets
  
  
  
     June 30,
2016
     December 31,
2015
 

Interest rate swap contracts fair value

   $ 1,721       $ 881   
  

 

 

    

 

 

 

Balance sheet location

    
 
 
Accrued Interest
Payable and Other
Liabilities
  
  
  
    
 
 
Accrued Interest
Payable and Other
Liabilities
  
  
  

Derivative Financial Instruments Acquired from PC Bancorp

At June 30, 2016, the Company also has nineteen pay-fixed, receive-variable, interest rate swaps with one counterparty bank that are designed to convert fixed rate loans into variable rate loans.

The following table presents the notional amount and the fair values of the asset and liability of the Company’s derivative instruments acquired from PC Bancorp as of the dates indicated (dollars in thousands):

 

     Fair Value Hedges  
     June 30,
2016
     December 31,
2015
 

Total interest rate contracts notional amount

   $ 25,350       $ 25,938   
  

 

 

    

 

 

 

Derivatives not designated as hedging instruments:

     

Interest rate swap contracts fair value

   $ 222       $ 313   

Derivatives designated as hedging instruments:

     

Interest rate swap contracts fair value

     1,190         1,351   
  

 

 

    

 

 

 

Total interest rate contracts fair value

   $ 1,412       $ 1,664   
  

 

 

    

 

 

 

Balance sheet location

    
 
 
 
Accrued
Interest Payable
and Other
Liabilities
  
  
  
  
    
 
 
 
Accrued
Interest Payable
and Other
Liabilities
  
  
  
  

 

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The Effect of Derivative Instruments on the Consolidated Statements of Income

The following table summarizes the effect of derivative financial instruments on the consolidated statements of income for the periods indicated (dollars in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2016      2015      2016      2015  

Derivatives not designated as hedging instruments:

           

Interest rate swap contracts – loans

           

Increase in fair value of interest rate swap contracts

   $ 52       $ 57       $ 91       $ 84   

Payments on interest rate swap contracts on loans

     (60      (66      (122      (132
  

 

 

    

 

 

    

 

 

    

 

 

 

Net decrease in other non-interest income

     (8      (9      (31      (48
  

 

 

    

 

 

    

 

 

    

 

 

 

Derivatives designated as hedging instruments:

           

Interest rate swap contracts – loans

           

Increase in fair value of interest rate swap contracts

   $ 139       $ 356       $ 162       $ 441   

Increase (decrease) in fair value of hedged loans

     71         (73      284         88   

Payment on interest rate swap contracts on loans

     (224      (285      (454      (571
  

 

 

    

 

 

    

 

 

    

 

 

 

Net decrease in interest income on loans

   $ (14    $ (2    $ (8    $ (42
  

 

 

    

 

 

    

 

 

    

 

 

 

Under all of the Company’s interest rate swap contracts, the Company is required to pledge and maintain collateral for the credit support under these agreements. At June 30, 2016, the Company has pledged $2.6 million in investment securities, $2.7 million in certificates of deposit, for a total of $5.3 million, as collateral under the swap agreements.

 

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Note 10 – Balance Sheet Offsetting

Assets and liabilities relating to certain financial instruments, including derivatives, and securities sold under repurchase agreements (“Repos”), may be eligible for offset in the consolidated balance sheets as permitted under accounting guidance. The Company’s interest rate swap derivatives are subject to a master bilateral netting and offsetting arrangement under specific conditions as defined within a master agreement governing all interest rate swap contracts that the Company and the counterparty banks have entered into. In addition, the master agreement under which the interest rate contracts have been written require the pledging of assets by the Company based on certain risk thresholds. The Company has pledged a certificate of deposit and investment securities as collateral under the swap agreements. The pledged collateral under the swap agreements are reported in the Company’s consolidated balance sheets, unless the Company defaults under the master agreement. The Company currently does not net or offset the interest rate swap contracts in its consolidated balance sheets, as reflected within the table below.

The Company’s securities sold under repurchase agreements represent transactions the Company has entered into with several deposit customers. These transactions represent the sale of securities on an overnight or on a term basis to our deposit customers under an agreement to repurchase the securities from the customers the next business day or at maturity. There is an individual contract for each customer with only one transaction per customer. There is no master agreement that provides for the netting arrangement or the offsetting of these individual transactions or for the netting of collateral positions. The Company does not net or offset the Repos in its consolidated balance sheets as reflected within the table below.

The table below presents the Company’s financial instruments that may be eligible for offsetting which include securities sold under agreements to repurchase that have no enforceable master netting arrangement and derivative securities that could be offset in the consolidated financial statements due to an enforceable master netting arrangement (dollars in thousands):

 

    Gross
Amounts
Recognized
in the
Consolidated
Balance
Sheets
    Gross
Amounts
Offset in the
Consolidated
Balance
Sheets
    Net Amounts
of Assets /
Liabilities
Presented
in the
Consolidated
Balance
Sheets
    Gross Amounts
Not Offset in the
Consolidated Balance Sheets
    Net Amount
(Collateral

over liability
balance
required to
be pledged)
 
        Financial
Instruments
    Collateral
Pledged
   

June 30, 2016

           

Financial Assets:

           

Interest rate swap contracts fair value (See Note 9 – Derivative Financial Instruments)

  $ 1,721      $ —        $ 1,721      $ 1,721      $ —        $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,721      $ —        $ 1,721      $ 1,721      $ —        $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financial Liabilities:

           

Interest rate swap contracts fair value (See Note 9 – Derivative Financial Instruments)

  $ 3,133      $ —        $ 3,133      $ 3,133      $ 5,362      $ 2,229   

Securities sold under agreements to repurchase (See Note 8 – Borrowings and Subordinated Debentures)

    25,782        —          25,782        25,782        57,525        31,743   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 28,915      $ —        $ 28,915      $ 28,915      $ 62,887      $ 33,972   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    Gross
Amounts
Recognized
in the
Consolidated
Balance
Sheets
    Gross
Amounts
Offset in the
Consolidated
Balance
Sheets
    Net Amounts
of Assets /
Liabilities
Presented
in the
Consolidated
Balance
Sheets
    Gross Amounts
Not Offset in the
Consolidated Balance Sheets
    Net Amount
(Collateral
over liability
balance
required to
be pledged)
 
          Financial
Instruments
    Collateral
Pledged
   

December 31, 2015

           

Financial Assets:

           

Interest rate swap contracts fair value (See Note 9 – Derivative Financial Instruments)

  $ 881      $ —        $ 881      $ 881      $ —        $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 881      $ —        $ 881      $ 881      $ —        $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financial Liabilities:

           

Interest rate swap contracts fair value (See Note 9 – Derivative Financial Instruments)

  $ 2,545      $ —        $ 2,545      $ 2,545      $ 4,759      $ 2,214   

Securities sold under agreements to repurchase (See Note 8 – Borrowings and Subordinated Debentures)

    14,360        —          14,360        14,360        46,596        32,236   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 16,905      $ —        $ 16,905      $ 16,905      $ 51,355      $ 34,450   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Note 11 - Stock Options and Restricted Stock

Equity Compensation Plans

The Company’s 2007 Equity and Incentive Plan (“Equity Plan”) was adopted by the Company in 2007 and replaced two prior equity compensation plans. The Equity Plan provides for significant flexibility in determining the types and terms of awards that may be made to participants. The Equity Plan was revised and approved by the Company’s shareholders in 2011 and adopted by the Company as part of the Bank holding company reorganization. This plan is designed to promote the interest of the Company in aiding the Company to attract and retain employees, officers and non-employee directors who are expected to contribute to the future success of the organization. The Equity Plan is intended to provide participants with incentives to maximize their efforts on behalf of the Company through stock-based awards that provide an opportunity for stock ownership. This plan provides the Company with a flexible equity incentive compensation program, which allows the Company to grant stock options, restricted stock, restricted stock award units and performance units. Certain options and share awards provide for accelerated vesting, if there is a change in control, as defined in the Equity Plan. These plans are described more fully in Note 16 - Stock Options and Restricted Stock in the Company’s Form 10-K for the year ended December 31, 2015.

At June 30, 2016, future compensation expense related to unvested restricted stock grants are reflected in the table below (dollars in thousands):

 

Future Restricted Stock Expense

 

Remainder of 2016

   $ 1,691   

2017

     1,676   

2018

     641   

2019

     173   

Thereafter

     31   
  

 

 

 

Total

   $ 4,212   
  

 

 

 

At June 30, 2016, the weighted-average period over which the total compensation cost related to unvested restricted stock grants not yet recognized is 2.7 years. There was no future compensation expense related to unvested stock options as of June 30, 2016. All stock options outstanding at June 30, 2016 are vested.

 

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Stock Options

No stock options have been granted by the Company since 2010.

The following table summarizes the share option activity under the plans as of the date and for the period indicated:

 

     Shares      Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Term
(in years)
     Aggregate
Intrinsic
Value
(in thousands)
 

Outstanding stock options at December 31, 2015

     557,471       $ 10.57         0.8       $ 8,248   

Granted

     —              

Exercised

     (396,964         

Forfeited

     —              

Expired

     (4,500         
  

 

 

          

Outstanding stock options at June 30, 2016

     156,007       $ 14.99         1.0       $ 1,189   
  

 

 

          

Exercisable options at June 30, 2016

     156,007       $ 14.99         1.0       $ 1,189   

Unvested options at June 30, 2016

     —         $ —           —         $ —     

The total intrinsic value of options exercised during the three months ended June 30, 2016 and 2015 was $2.7 million and $697 thousand, and during the six months ended June 30, 2016 and 2015, was $5.6 million and $1.3 million, respectively.

Restricted Stock

The weighted-average grant-date fair value per share in the table below is calculated by taking the total aggregate cost of the restricted shares issued divided by the number of shares of restricted stock issued. The aggregate cost of the restricted stock was calculated by multiplying the number of shares granted at each of the grant dates by the closing stock price of the Company’s common stock on the date of the grant. The following table summarizes the restricted stock activity under the Equity Plan for the period indicated:

 

     Number of Shares      Weighted-Average
Grant-Date Fair Value
per Share
 

Restricted Stock:

     

Unvested at December 31, 2015

     311,458       $ 19.29   

Granted

     113,809         22.87   

Vested

     (37,575      18.95   

Cancelled and forfeited

     (4,000      19.52   
  

 

 

    

Unvested at June 30, 2016

     383,692       $ 20.58   
  

 

 

    

Restricted stock compensation expense was $891 thousand and $807 thousand for the three month period ended June 30, 2016 and 2015, and $1.7 million and $1.3 million for the six month period ended June 30, 2016 and 2015, respectively. Restricted stock awards reflected in the table above are valued at the closing stock price on the date of grant and are expensed to stock based compensation expense over the period for which the related service is performed. In 2015, the Company granted 40,000 shares of Restricted Stock Unit (“RSU”) under the Equity Plan to one of its executive officers. Such grant is reflected in the table above. The shares of common stock underlying the 40,000 shares of RSU will not be issued until the RSUs vest and are not included in the Company’s shares issued and outstanding as of June 30, 2016. The RSUs are valued at the closing stock price on the date of grant and are expensed to stock based compensation expense over the period for which the related service is performed.

 

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Note 12 – Shareholders’ Equity

Common Stock

Holders of shares of the Company’s common stock are entitled to one vote for each share held of record on all matters voted upon by shareholders. Furthermore, the holders of the Company’s common stock have no preemptive rights to subscribe for new issue securities, and shares of the Company’s common stock are not subject to redemption, conversion, or sinking fund provisions.

With respect to the payment of dividends, after the preferential dividends upon all other classes and series of stock entitled thereto have been paid or declared and set apart for payment, then the holders of the Company’s common stock are entitled to such dividends as may be declared by the Company’s board of directors out of funds legally available under the laws of the State of California.

Upon the Company’s liquidation or dissolution, the assets legally available for distribution to holders of the Company’s shares of common stock, after payment of all the Company’s obligations and payment of any liquidation preference of all other classes and series of stock entitled thereto, including the Company’s preferred stock, are distributable ratably among the holders of the Company’s common stock.

During 2016, the Company issued 396,964 shares of stock from the exercise of stock options for a total value of $3.5 million. The Company also issued 113,809 shares of restricted stock to the Company’s directors and employees, cancelled 4,000 shares of unvested restricted stock related to employee turnover and cancelled 13,781 shares of restricted stock that had a value of $305 thousand when employees elected to pay their tax obligation via the repurchase of the stock by the Company. The net issuance of restricted stock for 2016 was 96,028 shares. The Equity Plan, as amended, allows employees to make an election to have a portion of their restricted stock that became vested during the year repurchased by the Company to provide funds to pay the employee’s tax obligation related to the vesting of the stock.

Preferred Stock

The Company completed the merger with 1st Enterprise on November 30, 2014. As part of the Merger Agreement, 16,400 shares of preferred stock issued by 1st Enterprise as part of the Small Business Lending Fund (SBLF) program of the United States Department of the Treasury was converted into 16,400 CU Bancorp preferred shares with substantially identical terms. CU Bancorp Preferred Stock has a liquidation preference amount of $1 thousand per share, designated as the Company’s Non-Cumulative Perpetual Preferred Stock, Series A. The U.S. Department of the Treasury is the sole holder of all outstanding shares of CU Bancorp Preferred Stock. The CU Bancorp Preferred Stock had an estimated life of four years and the fair value was $16 million at the merger date, resulting in a net discount of $479 thousand. The life-to-date and the year-to-date accretion on the net discount as of June 30, 2016 are $1.2 million and $91 thousand, respectively. The net carrying value of the CU Bancorp Preferred Stock is $17 million ($16 million plus of $0.7 million net premium) as of June 30, 2016.

Dividends on the Company’s Series A Preferred Stock are payable quarterly in arrears if authorized and declared by the Company’s board of directors out of legally available funds, on a non-cumulative basis, on the $1 thousand per share liquidation preference amount. Dividends are payable on January 1, April 1, July 1 and October 1 of each year. The current coupon dividend rate was adjusted to 9% on March 1, 2016 through perpetuity. However, the dividend yield through November 30, 2018 approximates 7% as a result of business combination accounting. Dividends on the Series A Preferred Stock are non-cumulative. There is no sinking fund with respect to dividends on the Series A Preferred Stock. So long as the Company’s Series A Preferred Stock remains outstanding, the Company may declare and pay dividends on the common stock only if full dividends on all outstanding shares of Series A Preferred Stock for the most recently completed dividend period have been or are contemporaneously declared and paid. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Company, holders of the Series A Preferred Stock will be entitled to receive for each share of Series A Preferred Stock, out of the Company’s assets or proceeds available for distribution to the Company’s shareholders, subject to any rights of the Company’s creditors, before any distribution of assets or proceeds is made to or set aside for the holders of the common stock, payment of an amount equal to the sum of (i) the $1 thousand liquidation preference amount per share and (ii) the amount of any accrued and unpaid dividends on the Series A Preferred Stock. To the extent the assets or proceeds available for distribution to shareholders are not sufficient to fully pay the liquidation payments owing to the holders of the Series A Preferred Stock and the holders of any other class or series of the stock ranking equally with the Series A Preferred Stock, the holders of the Series A Preferred Stock and such the Company’s stock will share ratably in the distribution. Holders of the Series A Preferred Stock have no right to exchange or convert their shares into common stock or any other securities and do not have voting rights.

 

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Other Comprehensive Income (Loss)

The following table presents the changes in accumulated other comprehensive income (loss) by component for the periods indicated (dollars in thousands):

 

     Before Tax      Tax Effect      Net of Tax  

Three Months Ended – June 30, 2016

        

Net unrealized gains (losses) on investment securities:

        

Beginning balance

   $ (81    $ 34       $ (47

Net unrealized gains arising during the period

     1,423         (598      825   
  

 

 

    

 

 

    

 

 

 

Ending balance

   $ 1,342       $ (564    $ 778   
  

 

 

    

 

 

    

 

 

 
     Before Tax      Tax Effect      Net of Tax  

Three Months Ended – June 30, 2015

        

Net unrealized gains (losses) on investment securities:

        

Beginning balance

   $ 1,215       $ (514    $ 701   

Net unrealized gains arising during the period

     (1,297      548         (749
  

 

 

    

 

 

    

 

 

 

Ending balance

   $ (82    $ 34       $ (48
  

 

 

    

 

 

    

 

 

 
     Before Tax      Tax Effect      Net of Tax  

Six Months Ended – June 30, 2016

        

Net unrealized gains (losses) on investment securities:

        

Beginning balance

   $ (1,409    $ 593       $ (816

Net unrealized gains arising during the period

     2,751         (1,157      1,594   
  

 

 

    

 

 

    

 

 

 

Ending balance

   $ 1,342       $ (564    $ 778   
  

 

 

    

 

 

    

 

 

 
     Before Tax      Tax Effect      Net of Tax  

Six Months Ended – June 30, 2015

        

Net unrealized gains (losses) on investment securities:

        

Beginning balance

   $ 333       $ (143    $ 190   

Net unrealized gains arising during the period

     (415      177         (238
  

 

 

    

 

 

    

 

 

 

Ending balance

   $ (82    $ 34       $ (48
  

 

 

    

 

 

    

 

 

 

Note 13 - Commitments and Contingencies

Litigation

From time to time the Company is a party to claims and legal proceedings arising in the ordinary course of business. The Company accrues for any probable loss contingencies that are estimable and discloses any material losses. As of June 30, 2016, there were no legal proceedings against the Company the outcome of which are expected to have a material adverse impact on the Company’s financial position, results of operations or cash flows, as a whole.

Financial Instruments with Off Balance Sheet Risk

See Note 21 – Commitments and Contingencies in the Company’s Form 10-K for the year ended December 31, 2015. Financial instruments with off balance sheet risk include commitments to extend credit of $871 million and $806 million at June 30, 2016 and December 31, 2015, respectively. Included in the aforementioned commitments were standby letters of credit outstanding of $87 million and $73 million at June 30, 2016 and December 31, 2015. The Company also has a reserve for estimated losses on unfunded loan commitments of $726 thousand and $608 thousand at June 30, 2016 and December 31, 2015, respectively. These balances are included in other liabilities on the consolidated balance sheets.

 

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Note 14 - Fair Value Information

Fair Value Measurement

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including both those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis and a non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value, and for estimating the fair value of financial assets and financial liabilities not recorded at fair value, are discussed below.

In accordance with accounting guidance, the Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are as follows:

 

    Level 1 – Observable unadjusted quoted market prices in active markets for identical assets and liabilities that the reporting entity has the ability to access at the measurement date.

 

    Level 2 – Significant other observable market based inputs, other than Level 1 prices such as quoted prices for similar assets or liabilities or unobservable inputs that are corroborated by market data. This includes quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data, either directly or indirectly. This would include those financial instruments that are valued using models or other valuation methodologies where substantially all of the assumptions are observable in the marketplace, can be derived from observable market data or are supported by observable levels at which transactions are executed in the marketplace.

 

    Level 3 – Significant unobservable inputs that reflect a reporting entity’s evaluation about the assumptions that market participants would use in pricing an asset or liability. Assets measured utilizing level 3 are for positions that are not traded in active markets or are subject to transfer restrictions, and or where valuations are adjusted to reflect illiquidity and or non-transferability. These assumptions are not corroborated by market data. This is comprised of financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are generally less readily observable from objective sources. Management uses a combination of reviews of the underlying financial statements, appraisals and management’s judgment regarding credit quality to determine the value of the financial asset or liability.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Management maximizes the use of observable inputs and attempts to minimize the use of unobservable inputs when determining fair value measurements. The following is a description of both the general and specific valuation methodologies used for certain instruments measured at fair value, as well as the general classification of these instruments pursuant to the valuation hierarchy.

Investment Securities Available-for-Sale and Held-to-Maturity: The fair value of securities available-for-sale and held-to-maturity may be determined by obtaining quoted prices in active markets, when available, from nationally recognized securities exchanges (Level 1 financial assets). If quoted market prices are not available, the fair value is determined by matrix pricing, which is a mathematical technique widely used in the securities industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities which are observable market inputs (Level 2 financial assets). Debt securities’ pricing is generally obtained from one of the matrix pricing models developed from one of the three national pricing agencies. In cases where significant credit valuation adjustments are incorporated into the estimation of fair value, reported amounts are classified as Level 3 financial assets.

Securities classified as available-for-sale are accounted for at their current fair value rather than amortized historical cost. Unrealized gains or losses are excluded from net income and reported as an amount net of taxes as a separate component of accumulated other comprehensive income included in shareholders’ equity. Securities classified as held-to-maturity are accounted for at their amortized historical cost.

 

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The Company considers the inputs utilized to fair value the available-for-sale and held-to-maturity investment securities to be observable market inputs and classified these financial assets within the Level 2 fair value hierarchy. Management bases the fair value for these investments primarily on third party price indications provided by independent pricing sources utilized by the Company’s bond accounting system to obtain market pricing on its individual securities. Vining Sparks, who provides the Company with its bond accounting system, utilizes pricing from three independent third party pricing sources for pricing of securities. These third party pricing sources utilize quoted market prices, or when quoted market prices are not available, the fair values are estimated using nationally recognized third-party vendor pricing models, of which the inputs are observable. However, the fair value reported may not be indicative of the amounts that could be realized in an actual market exchange.

The fair value of the Company’s U.S. Agency and available-for-sale and held-to-maturity investment securities are calculated using an option adjusted spread model from one of the nationally recognized third-party pricing models. Depending on the assumptions used and the treasury yield curve and other interest rate assumptions, the fair value could vary significantly in the near term.

Loans: The fair value for loans is estimated by discounting the expected future cash flows using current interest rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities. Loans are segregated by type such as commercial and industrial, commercial real estate, construction and other loans with similar credit characteristics and are further segmented into fixed and variable interest rate loan categories. Expected future cash flows are projected based on contractual cash flows, adjusted for estimated credit losses and estimated prepayments. The inputs utilized in determining the fair value of loans are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.

Impaired Loans: The fair value of impaired loans is determined based on an evaluation at the time the loan is originally identified as impaired, and periodically thereafter, at the lower of cost or fair value. Fair value on impaired loans is measured based on the value of the collateral securing these loans, less costs to sell, if the loan is collateral dependent, or based on the cash flows for non-collateral dependent loans discounted at the loan’s original effective rate. Collateral dependent loans may be secured by either real estate and/or business assets including equipment, inventory and/or accounts receivable and is determined based on appraisals performed by qualified licensed appraisers hired by the Company. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Such discounts are typically significant and unobservable. For unsecured loans, the estimated future discounted cash flows of the business or borrower, are used in evaluating the fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. The inputs utilized in determining the fair value of impaired loans are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.

Interest Rate Swap Contracts: The fair value of the interest rate swap contracts are provided by independent third party vendors that specialize in interest rate risk management and fair value analysis using a model that utilizes current market data to estimate cash flows of the interest rate swaps utilizing the future London Interbank Offered Rate (“LIBOR”) yield curve for accruing and the future Overnight Index Swap Rate (“OIS”) yield curve for discounting through the maturity date of the interest rate swap contract. The future LIBOR yield curve is the primary input in the valuation of the interest rate swap contracts. Both the LIBOR and OIS yield curves are readily observable in the marketplace. Accordingly, the interest rate swap contracts are classified within Level 2 of the fair value hierarchy.

Other Real Estate Owned: The fair value of other real estate owned is generally based on real estate appraisals (unless more current market information is available) less estimated costs to sell. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant. The inputs utilized in determining the fair value of other real estate owned are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.

SBA Servicing Asset: A servicing asset is recorded at fair value upon the sale of an SBA loan. The fair value of this asset is based on the estimated discounted future cash flows utilizing market based discount rates and estimated prepayment speeds. The discount rate was based on the current U.S. Treasury yield curve, plus a spread for marketplace risk associated with these assets. Prepayment speeds were selected based on the historical prepayments of similar SBA pools. The prepayment speeds determine the timing of the cash flows. The SBA servicing asset is amortized over the contractual life of the loans based on

 

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an effective yield approach. In addition, the Company’s servicing asset is evaluated regularly for impairment by discounting the estimated future cash flows using market-based discount rates and prepayment speeds. If the calculated present value of the servicing asset declines below the Company’s current carrying value, the servicing asset is written down to its present value. Based on the Company’s methodology in its valuation of the SBA servicing asset, the current carrying value is estimated to approximate the fair value. The inputs utilized in determining the fair value of SBA servicing asset are unobservable and accordingly, these financial assets are classified within Level 3 of the fair value hierarchy.

Non-Maturing Deposits: The fair values for non-maturing deposits (deposits with no contractual termination date), which include non-interest bearing demand deposits, interest bearing transaction accounts, money market deposits and savings accounts are equal to their carrying amounts, which represent the amounts payable on demand. Because the carrying value and fair value are by definition identical, and accordingly non-maturity deposits are classified within Level 1 of the fair value hierarchy, these balances are not listed in the following tables.

Maturing Deposits: The fair values of fixed maturity certificates of deposit (time deposits) are estimated using a discounted cash flow calculation that applies current market deposit interest rates to the Company’s current certificates of deposit interest rates for similar term certificates. The inputs utilized in determining the fair value of maturing deposits are observable and accordingly, these financial liabilities are classified within Level 2 of the fair value hierarchy.

Securities Sold under Agreements to Repurchase (“Repos”): The fair value of securities sold under agreements to repurchase is estimated based on the discounted value of future cash flows expected to be paid on the deposits. The carrying amounts of Repos with maturities of 90 days or less approximate their fair values. The fair value of Repos with maturities greater than 90 days is estimated based on the discounted value of the contractual future cash flows. The inputs utilized in determining the fair value of securities sold under agreements to repurchase are observable and accordingly, these financial liabilities are classified within Level 2 of the fair value hierarchy.

Subordinated Debentures: The fair value of the three variable rate subordinated debentures (“debentures”) is estimated using a discounted cash flow calculation that applies the three month LIBOR plus the margin index at June 30, 2016, to the cash flows from the debentures, based on the actual interest rate the debentures were accruing at June 30, 2016. Because all three of the debentures re-priced on June 15, 2016 based on the current three month LIBOR index rate plus the index margin at that date, and with relatively little to no change in the three month LIBOR index rate from the re-pricing date through June 30, 2016, the current face value of the debentures and their calculated fair value are approximately equal. The inputs utilized in determining the fair value of subordinated debentures are observable and accordingly, these financial liabilities are classified within Level 2 of the fair value hierarchy.

Fair Value of Commitments: Loan commitments that are priced on an index plus a margin to a market rate of interest are reported at the carrying value of the loan commitment. Loan commitments on which the committed fixed interest rate is less than the current market rate were insignificant at June 30, 2016 and December 31, 2015.

 

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Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table summarizes the financial assets and financial liabilities measured at fair value on a recurring basis as of the dates indicated, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (dollars in thousands):

 

     Fair
Value
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Financial Assets – June 30, 2016

           

Investment securities available-for-sale

   $ 334,113       $ —         $ 334,113       $ —     

Interest Rate Swap Contracts

     1,721         —           1,721         —     

Financial Liabilities – June 30, 2016

           

Interest Rate Swap Contracts

   $ 3,133       $ —         $ 3,133       $ —     

Financial Assets – December 31, 2015

           

Investment securities available-for-sale

   $ 315,785       $ —         $ 315,785       $ —     

Interest Rate Swap Contracts

     881         —           881         —     

Financial Liabilities – December 31, 2015

           

Interest Rate Swap Contracts

   $ 2,545       $ —         $ 2,545       $ —     

At June 30, 2016 and at December 31, 2015 the Company had no financial assets or liabilities that were measured at fair value on a recurring basis that required the use of significant unobservable inputs (Level 3). Additionally, there were no transfers of assets either between Level 1 and Level 2 nor in or out of Level 3 of the fair value hierarchy for assets measured on a recurring basis for the period ended June 30, 2016.

 

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Assets Measured at Fair Value on a Non-recurring Basis

The Company may be required periodically, to measure certain financial assets and financial liabilities at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). These include assets that are measured at the lower of cost or fair value that were recognized at fair value below cost at the end of or during the period.

There were no transfers of assets either between Level 1 and Level 2 nor in or out of Level 3 of the fair value hierarchy for assets measured on a non-recurring basis during the three or six months ended June 30, 2016.

The following table presents the balances of assets and liabilities measured at fair value on a non-recurring basis by caption and by level within the fair value hierarchy as of the dates indicated (dollars in thousands):

 

    Fair
Value
    Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
    Significant
Other
Observable
Inputs
(Level 2)
    Significant
Unobservable
Inputs
(Level 3)
 

Financial Assets – June 30, 2016

       

Collateral dependent impaired loans with specific valuation allowance and/or partial charge-offs (non-purchased credit impaired loans)

  $ 306      $ —        $ —        $ 306   

Other real estate owned

    —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 306      $ —        $ —        $ 306   
 

 

 

   

 

 

   

 

 

   

 

 

 

Financial Assets – December 31, 2015

       

Collateral dependent impaired loans with specific valuation allowance and/or partial charge-offs (non-purchased credit impaired loans)

  $ —        $ —        $ —        $ —     

Other real estate owned

    325        —          —          325   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 325      $ —        $ —        $ 325   
 

 

 

   

 

 

   

 

 

   

 

 

 

The following table presents the significant unobservable inputs used in the fair value measurements for Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of the dates indicated (dollars in thousands):

 

    Fair
Value
    Valuation
Methodology
    Valuation Model
and/or Factors
    Unobservable
Input Values
 

Financial Assets – June 30, 2016

       

Collateral dependent impaired loans with specific valuation allowance and/or partial charge-off

  $ 221       
 
 
Credit loss estimate of
aged accounts
receivable collateral
  
  
  
   
 
 
Credit loss factors on
aging of accounts
receivable collateral
  
  
  
    40
    85        Auction estimate       
 
Sales approach
Estimated selling costs
  
  
    10
 

 

 

       

Total

  $ 306         
 

 

 

       

Financial Assets – December 31, 2015

       

Collateral dependent impaired loans with specific valuation allowance and/or partial charge-off

  $ —          —          —          —     

Other real estate owned

  $ 325       
 
Broker opinion of
value
  
  
   
 
Sales approach
Estimated selling costs
  
  
    6
 

 

 

       

Total

  $ 325         
 

 

 

       

 

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Fair Value of Financial Assets and Liabilities

ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or on a non-recurring basis. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to develop the estimates of fair value. Accordingly, the estimates presented below are not necessarily indicative of the amounts the Company could have realized in a current market exchange as of June 30, 2016 and December 31, 2015. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The description of the valuation methodologies used for assets and liabilities measured at fair value and for estimating fair value for financial instruments not recorded at fair value has been described above.

The table below presents the carrying amounts and fair values of financial instruments based on their fair value hierarchy indicated (dollars in thousands):

 

                   Fair Value Measurements  
     Carrying
Amount
     Fair Value      Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

June 30, 2016

              

Financial Assets

              

Investment securities available-for-sale

   $ 334,113         334,113       $ —         $ 334,113       $ —     

Investment securities held-to-maturity

     40,595         41,450         —           41,450         —     

Loans, net

     1,932,635         1,972,144         —           —           1,972,144   

Interest rate swap contracts

     1,721         1,721         —           1,721         —     

Financial Liabilities

              

Certificates of deposit

     51,598         51,598         —           51,598         —     

Securities sold under agreements to repurchase

     25,782         25,782         —           25,782         —     

Subordinated debentures

     9,777         12,372         —           12,372         —     

Interest rate swap contracts

     3,133         3,133         —           3,133         —     

December 31, 2015

              

Financial Assets

              

Investment securities available-for-sale

   $ 315,785         315,785       $ —         $ 315,785       $ —     

Investment securities held-to-maturity

     42,036         42,339         —           42,339         —     

Loans, net

     1,817,481         1,851,220         —           —           1,851,220   

Interest rate swap contracts

     881         881         —           881         —     

Financial Liabilities

                 —     

Certificates of deposit

     58,502         58,502         —           58,502         —     

Securities sold under agreements to repurchase

     14,360         14,360         —           14,360         —     

Subordinated debentures

     9,697         12,372         —           12,372         —     

Interest rate swap contracts

     2,545         2,545         —           2,545         —     

Note 15 – Subsequent Events

We have evaluated events that have occurred subsequent to June 30, 2016 and have concluded there are no subsequent events that would require disclosure or recognition in the accompanying interim consolidated financial statements.

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

See “Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995” below relating to “forward-looking” statements included in this report.

The following is management’s discussion and analysis of the major factors that influenced the results of the operations and financial condition of CU Bancorp, (“the Company”) for the current period. This analysis should be read in conjunction with the audited financial statements and accompanying notes included in the Company’s 2015 Annual Report on Form 10-K and with the unaudited financial statements and notes as set forth in this report.

CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE

PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

We have made forward-looking statements in this document about the Company, for which the Company claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995.

The Company’s forward-looking statements include descriptions of plans or objectives of management for future operations, products or services, and forecasts of its revenues, earnings or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “assume,” “plan,” “predict” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.”

We make forward-looking statements as set forth above and regarding projected sources of funds, availability of acquisition and growth opportunities, dividends, adequacy of our allowance for loan losses and provision for loan losses, our loan portfolio and subsequent charge-offs. Forward-looking statements involve substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. There are many factors that could cause actual results to differ materially from those contemplated by these forward-looking statements. Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the SEC, Item 1A of our Annual Report on Form 10-K, and the following:

 

    Current and future economic and market conditions in the United States generally or in the communities we serve, including the effects of declines in property values, high unemployment rates and overall slowdowns in economic growth should these events occur.

 

    The effects of trade, monetary and fiscal policies and laws.

 

    Possible losses of businesses and population in Los Angeles, Orange, Ventura, San Bernardino or Riverside Counties.

 

    Loss of customer checking and money-market account deposits as customers pursue other higher-yield investments, particularly in a rising interest rate environment.

 

    Possible changes in consumer and business spending and saving habits and the related effect on our ability to increase assets and to attract deposits.

 

    Competitive market pricing factors.

 

    Deterioration in economic conditions that could result in increased loan losses.

 

    Risks associated with concentrations in real estate related loans.

 

    Risks associated with concentrations in deposits.

 

    Loss of significant customers.

 

    Market interest rate volatility.

 

    Possible changes in the creditworthiness of customers and the possible impairment of the collectability of loans.

 

    Changes in the speed of loan prepayments, loan origination and sale volumes, loan loss provisions, charge offs or actual loan losses.

 

    Compression of our net interest margin.

 

    Stability of funding sources and continued availability of borrowings to the extent necessary.

 

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    Changes in legal or regulatory requirements or the results of regulatory examinations that could restrict growth.

 

    The inability of our internal disclosure controls and procedures to prevent or detect all errors or fraudulent acts.

 

    Inability of our framework to manage risks associated with our business, including operational risk and credit risk, to mitigate all risk or loss to us.

 

    Our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, “denial of service” attacks, “hacking” and identity theft.

 

    The effects of man-made and natural disasters, including earthquakes, floods, droughts, brush fires, tornadoes and hurricanes.

 

    The effect of labor and port slowdowns on small businesses.

 

    Risks of loss of funding for the Small Business Administration (“SBA”), or SBA loan programs, or changes in those programs.

 

    Lack of take-out financing or problems with sales or lease-up with respect to our construction loans.

 

    Our ability to recruit and retain key management and staff.

 

    Availability of, and competition for, acquisition opportunities.

 

    Significant decline in the market value of the Company that could result in an impairment of goodwill.

 

    Regulatory limits on the Bank’s ability to pay dividends to the Company.

 

    The uncertainty of obtaining regulatory approval for various merger and acquisition opportunities.

 

    New accounting pronouncements.

 

    The impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) and related rules and regulations on the Company’s business operations and competitiveness.

 

    Our ability to comply with applicable capital and liquidity requirements (including the finalized Basel III capital standards), including our ability to generate capital internally or raise capital on favorable terms.

 

    Increased regulation of the securities markets, including the securities of the Company, whether pursuant to the Sarbanes-Oxley Act of 2002, or otherwise.

 

    The effects of any damage to our reputation resulting from developments related to any of the items identified above.

Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. You should consider any forward looking statements in light of this explanation, and we caution you about relying on forward-looking statements.

For a more complete discussion of these risks and uncertainties, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 and particularly, Item 1A, titled “Risk Factors.”

 

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OVERVIEW

CU Bancorp (the “Company”) is a bank holding company whose operating subsidiary is California United Bank. As a bank holding company, CU Bancorp is subject to regulation of the Federal Reserve Board (“FRB”). The term “Company”, as used throughout this document, refers to the consolidated financial statements of CU Bancorp and California United Bank.

California United Bank (the “Bank”) is a full-service commercial business bank offering a broad range of banking products and services including: deposit services, lending and cash management to small and medium-sized businesses in Los Angeles, Orange, Ventura, San Bernardino and Riverside counties, to non-profit organizations, to business principals and entrepreneurs, to the professional community, including attorneys, certified public accountants, financial advisors, healthcare providers and investors. The Bank opened for business in 2005, with its current headquarters office located in Los Angeles, California. As a state chartered non-member bank, the Bank is subject to regulation by the California Department of Business Oversight, (the “DBO”) and the Federal Deposit Insurance Corporation (“FDIC”). The deposits of the Bank are insured by the FDIC, to the maximum amount allowed by law.

Total assets increased $142 million or 5% from December 31, 2015 to $2.8 billion mainly due to deposit growth of $109 million and net income of $13 million. Loan growth during the six months ended June 30, 2016 was concentrated primarily in Other Nonresidential Property loans of $49 million, Construction, Land Development and Other Land loans of $40 million and Owner-Occupied Nonresidential Properties of $18 million. Funding the Company’s loan growth for the six months ended June 30, 2016 were increases in non-interest bearing demand deposits of $49 million and money market and savings deposits of $68 million. At both June 30, 2016 and December 31, 2015, non-interest bearing deposits represented 56% of total deposits. Tangible book value per common share was $13.46, $12.67 and $11.97 at June 30, 2016, December 31, 2015 and June 30, 2015, respectively.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Various elements of our accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions, and other subjective assessments. We have identified several accounting policies that, due to judgments, estimates, and assumptions inherent in those policies, are essential to an understanding of our consolidated financial statements. These policies relate to the accounting for business combinations, evaluation of goodwill for impairment, methodologies that determine our allowance for loan loss, the valuation of impaired loans, the classification and valuation of investment securities, accounting for derivatives financial instruments and hedging activities, and accounting for income taxes.

Our critical accounting policies are described in greater detail in our 2015 Annual Report on Form 10-K, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates. We believe that our most critical accounting policies upon which our financial condition depends, and which involve the most complex or subjective decisions or assessment, are as follows:

Business Combinations

The Company has a number of fair value adjustments recorded within the consolidated financial statements at June 30, 2016 that relate to the business combinations with California Oaks State Bank “COSB”, Premier Commercial Bancorp “PC Bancorp” and 1st Enterprise Bank “1st Enterprise” on December 31, 2010, July 31, 2012 and November 30, 2014, respectively. These fair value adjustments include goodwill, fair value adjustments on loans, core deposit intangible assets, other intangible assets, fair value adjustments to acquired lease obligations, fair value adjustments to certificates of deposit and fair value adjustments on derivatives. The assets and liabilities acquired through acquisitions have been accounted for at fair value as of the date of the acquisition. The goodwill that was recorded on the transactions represented the excess of the purchase price over the fair value of net assets acquired. Goodwill is not amortized and is reviewed for impairment on October 1st of each year. If an event occurs or circumstances change that result in the Company’s fair value declining below its book value, the Company would perform an impairment analysis at that time.

 

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Based on the Company’s 2015 goodwill impairment analysis, no impairment to goodwill has occurred. The Company is a sole reporting unit for evaluation of goodwill.

The core deposit intangibles on non-maturing deposits, which represent the intangible value of depositor relationships resulting from deposit liabilities assumed through acquisitions, are being amortized over the projected useful lives of the deposits. The weighted average remaining life of the core deposit intangible is estimated at approximately 6 years at June 30, 2016. Core deposit intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

Loans acquired through acquisition are recorded at fair value at acquisition date without a carryover of the related Allowance. Purchased Credit Impaired (“PCI”) loans are acquired loans with evidence of deterioration of credit quality since origination and it is probable, at the acquisition date, that the Company will not be able to collect all contractually required amounts. When the timing and/or amounts of expected cash flows on such loans are not reasonably estimable, no interest is accreted and the loan is reported as a non-accrual loan; otherwise, if the timing and amounts of expected cash flows for PCI loans are reasonably estimable, then interest is accreted and the loans are reported as accruing loans. The non-accretable difference represents the difference between the undiscounted contractual cash flows and the undiscounted expected cash flows, and also reflects the estimated credit losses in the acquired loan portfolio at the acquisition date and can fluctuate due to changes in expected cash flows during the life of the PCI loans. For non-PCI loans, loan fair value adjustments consist of an interest rate premium or discount and a credit component on each individual loan and are amortized to loan interest income based on the effective yield method over the remaining life of the loans. Subsequent decreases to the expected cash flows for both PCI and non-PCI loans will result in a provision for loan losses.

Allowance for Loan Loss

The allowance for loan loss (“Allowance”) is established by a provision for loan losses that is charged against income, increased by charges to expense and decreased by charge-offs (net of recoveries). Loan charge-offs are charged against the Allowance when management believes the collectability of loan principal becomes unlikely. Subsequent recoveries, if any, are credited to the Allowance.

The Allowance is an amount that management believes will be adequate to absorb estimated charge-offs related to specifically identified loans, as well as probable loan charge-offs inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior loss experience. Management carefully monitors changing economic conditions, the concentrations of loan categories and collateral, the financial condition of the borrowers, the history of the loan portfolio, as well as historical peer group loan loss data to determine the adequacy of the Allowance. The Allowance is based upon estimates, and actual charge-offs may vary from the estimates. No assurance can be given that adverse future economic conditions will not lead to delinquent loans, increases in the provision for loan losses and/or charge-offs. These evaluations are inherently subjective, as they require estimates that are susceptible to significant revisions as conditions change. In addition, regulatory agencies, as an integral part of their examination process, may require changes to the Allowance based on their judgment about information available at the time of their examinations. Management believes that the Allowance as of June 30, 2016 is adequate to absorb known and probable losses in the loan portfolio.

The Allowance consists of specific and general components. The specific component relates to loans that are categorized as impaired. For loans that are categorized as impaired, a specific allowance is established when the realizable value of the impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on the type of loan and historical charge-off experience adjusted for qualitative factors.

While the general allowance covers all non-impaired loans and is based on historical loss experience adjusted for the various qualitative factors, the change in the Allowance from one reporting period to the next may not directly correlate to the rate of change of nonperforming loans for the following reasons:

 

    A loan moving from the impaired performing status to an impaired non-performing status does not mandate an automatic increase in allowance. The individual loan is evaluated for a specific allowance requirement when the loan moves to the impaired status, not when the loan moves to non-performing status. In addition, the impaired loan is reevaluated at each subsequent reporting period. Impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the Company may measure impairment based on the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

 

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    Not all impaired loans require a specific allowance. The payment performance of the borrower may require an impaired classification, but the collateral evaluation may support adequate collateral coverage. For a number of impaired loans in which borrower performance is in question, the collateral coverage may be sufficient. In those instances, neither a general allowance nor a specific allowance is assessed.

Investment Securities

The Company currently classifies its investment securities under the available-for-sale and held-to-maturity classifications. Under the available-for-sale classification, securities can be sold in response to certain conditions, such as changes in interest rates, changes in the credit quality of the securities, when the credit quality of a security does not conform with current investment policy guidelines, fluctuations in deposit levels or loan demand or need to restructure the portfolio to better match the maturity or interest rate characteristics of liabilities with assets. Securities classified as available-for-sale are accounted for at their current fair value rather than amortized cost. Unrealized gains or losses are excluded from net income and reported as a separate component of accumulated other comprehensive income (loss) included in shareholders’ equity. Under the held-to-maturity classification, if the Company has the intent and the ability at the time of purchase to hold these securities until maturity, they are classified as held-to-maturity and are stated at amortized cost.

As of each reporting date, the Company evaluates the securities portfolio to determine if there has been an other-than-temporary impairment (“OTTI”) on each of the individual securities in the investment securities portfolio. If it is probable that the Company will be unable to collect all amounts due according to the contractual terms of a debt security not impaired at acquisition, an OTTI shall be considered to have occurred. Once an OTTI is considered to have occurred, the credit portion of the loss is required to be recognized in current earnings, while the non-credit portion of the loss is recorded as a separate component of shareholders’ equity.

In estimating whether an other-than-temporary impairment loss has occurred, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) the current liquidity and volatility of the market for each of the individual security categories, (iv) the current slope and shape of the Treasury yield curve, along with where the economy is in the current interest rate cycle, (v) the spread differential between the current spread and the long-term average spread for that security category, (vi) the projected cash flows from the specific security type, (vii) any financial guarantee and financial condition of the guarantor and (viii) the intent and ability of the Company to retain its investment in the issue for a period of time sufficient to allow for any anticipated recovery in fair value.

If it’s determined that an OTTI exists on a debt security, the Company then determines if (a) it intends to sell the security or (b) it is more likely than not that it will be required to sell the security before its anticipated recovery. If either of the conditions is met, the Company will recognize the amount of the OTTI in earnings equal to the difference between the security’s fair value and its adjusted cost basis. If neither of the conditions is met, the Company determines (a) the amount of the impairment related to credit loss and (b) the amount of the impairment due to all other factors. The difference between the present value of the cash flows expected to be collected and the amortized cost basis is the credit loss. The credit loss is the portion of the other-than-temporary impairment that is recognized in earnings and is a reduction to the cost basis of the security. The portion of total impairment related to all other factors is included in other comprehensive income. Significant judgment is required in this analysis that includes, but is not limited to assumptions regarding the collectability of principal and interest, future default rates, future prepayment speeds, the amount of current delinquencies that will result in defaults and the amount of eventual recoveries expected on the underlying collateral.

Realized gains and losses on sales of securities are recognized in earnings at the time of sale and are determined on a specific-identification basis. Purchase premiums and discounts are recognized in interest income using the interest method over the expected maturity term of the securities. For mortgage-backed securities, the amortization or accretion is based on estimated average lives of the securities. The lives of these securities can fluctuate based on the amount of prepayments received on the underlying collateral of the securities. The amount of prepayments varies from time to time based on the interest rate environment and the rate of turnover of mortgages.

 

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Derivative Financial Instruments and Hedging Activities

All derivative instruments (interest rate swap contracts) were recognized on the consolidated balance sheet at their current fair value. For derivatives designated as fair value hedges, changes in the fair value of the derivative and hedged item related to the hedged risk are recognized in earnings. Accounting Standards Codification (“ASC”) Topic 815 establishes the accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. ASC Topic 815 requires that changes in the derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Accounting for qualifying hedges allows a derivative’s gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.

On the date a derivative contract is entered into by the Company, the Company will designate the derivative contract as either a fair value hedge (i.e. a hedge of the fair value of a recognized asset or liability), a cash flow hedge (i.e. a hedge of the variability of cash flows to be received or paid related to a recognized asset or liability), or a stand-alone derivative (i.e. an instrument with no hedging designation). For a derivative designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as other non-interest income. At inception and on an ongoing basis, the derivatives that are used in hedging transactions are evaluated as to how effective they are in offsetting changes in fair values or cash flows of hedged items.

The Company will discontinue hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting change in the fair value of the hedged item, the derivative expires or is sold, is terminated, or management determines that designation of the derivative as a hedging instrument is no longer appropriate. When hedge accounting is discontinued, the Company will continue to carry the derivative on the balance sheet at its fair value (if applicable), but will no longer adjust the hedged asset or liability for changes in fair value. The adjustments of the carrying amount of the hedged asset or liability will be accounted for in the same manner as other components of the carrying amount of that asset or liability, and the adjustments are amortized to interest income over the remaining life of the hedged item upon the termination of hedge accounting.

Income Taxes

The Company provides for current federal and state income taxes payable and for deferred taxes that result from differences between financial accounting rules and tax laws governing the timing of recognition of various income and expense items. The Company recognizes deferred income tax assets and liabilities for the future tax effects of such temporary differences based on the difference between the financial statement and tax bases of the existing assets and liabilities using the statutory rate expected in the years in which the differences are expected to reverse. The effect on deferred taxes of any enacted change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established to the extent necessary to reduce the deferred tax asset to the level at which it is “more likely than not” that the tax assets or benefits will be realized. Realization of tax benefits for deductible temporary differences and loss carryforwards depends on having sufficient taxable income of an appropriate character within the carryback and carryforward period and that current tax law will allow for the realization of those tax benefits.

The Company is required to account for uncertainty associated with the tax positions it has taken or expects to be taken on past, current and future tax returns. Where there may be a degree of uncertainty as to the tax realization of an item, the Company may only record the tax effects (expense or benefits) from an uncertain tax position in the consolidated financial statements if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. Management does not believe that it has any material uncertain tax positions taken to date that are not more likely than not to be realized. Interest and penalties related to uncertain tax positions are recorded as part of other operating expense.

 

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RESULTS OF OPERATIONS

Key Performance Measures

The following table presents key performance measures for the periods indicated and the dollar and percentage changes between the periods (dollars in thousands, except per share data):

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     Amounts     Increase
(Decrease)
    Amounts     Increase
(Decrease)
 
     2016     2015     $     %     2016     2015     $     %  

Net Income Available to Common Shareholders

   $ 6,338      $ 4,955      $ 1,383        27.91   $ 12,322      $ 8,882      $ 3,440        38.73
  

 

 

   

 

 

       

 

 

   

 

 

     

Earnings per share

                

Basic

   $ 0.37      $ 0.30      $ 0.07        23.33   $ 0.72      $ 0.54      $ 0.18        33.33

Diluted

   $ 0.36      $ 0.29      $ 0.07        24.14   $ 0.71      $ 0.53      $ 0.18        33.96

Return on average assets (1)

     0.92     0.82     0.10     12.20     0.90     0.76     0.14     18.42

Return on average tangible common equity (2)

     10.93     10.00     0.93     9.30     10.85     9.13     1.72     18.84

Net interest margin (3)

     3.81     3.87     (0.06 )%      (1.55 )%      3.79     3.91     (0.12 )%      (3.07 )% 

Efficiency ratio (4)

     55.42     61.20     (5.78 )%      (9.44 )%      56.56     62.63     (6.07 )%      (9.69 )% 

 

(1) Return on average assets is calculated by dividing net income available to common shareholders by the average assets for the period.
(2) Return on average tangible common equity is calculated by dividing the Company’s net income available to common shareholders by average tangible common equity for the period. See the tables for return on average tangible common equity calculation and reconciliation to average common equity.
(3) Net interest margin represents net interest income as a percent of interest earning assets.
(4) Efficiency ratio represents non-interest expense as a percent of net interest income plus non-interest income, excluding gain on sale of securities, net.

Average Tangible Common Equity (TCE) Calculation and Reconciliation to Total Average Shareholders’ Equity

The Company utilizes the term TCE, a non-GAAP financial measure. The Company’s management believes TCE is useful because it is a measure utilized by both regulators and market analysts in evaluating the Company’s financial condition and capital strength. TCE represents common shareholders’ equity less goodwill and certain intangible assets. Return on Average Tangible Common Equity represents annualized net income available to common shareholders as a percent of average tangible common equity. A calculation of the Company’s Return on Average Tangible Common Equity is provided in the table below for the periods indicated (dollars in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2016     2015     2016     2015  

Average Tangible Common Equity Calculation

        

Total average shareholders’ equity

   $ 322,033      $ 287,930      $ 317,522      $ 285,430   

Less: Average serial preferred stock

     17,126        16,331        17,107        16,209   

Less: Average goodwill

     64,603        63,950        64,603        63,963   

Less: Average core deposit and leasehold right intangibles

     7,144        8,887        7,330        9,120   
  

 

 

   

 

 

   

 

 

   

 

 

 

Average Tangible Common Equity

   $ 233,160      $ 198,762      $ 228,482      $ 196,138   
  

 

 

   

 

 

   

 

 

   

 

 

 

Annualized Net Income Available to Common Shareholders

   $ 25,491      $ 19,874      $ 24,779      $ 17,911   

Return on Average Tangible Common Equity

     10.93     10.00     10.85     9.13

 

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Operations Performance Summary

Three Months Ended June 30, 2016 Compared to Three Months Ended June 30, 2015

Net income available to common shareholders for the three months ended June 30, 2016 was $6.3 million, or $0.36 per diluted share, compared to $5.0 million, or $0.29 per diluted share for the three months ended June 30, 2015. The $1.3 million increase, or 28%, was primarily due to a $2.5 million increase in loan interest income, which is the result of the Company’s strong organic loan growth since the prior period. In addition, the Company recorded no merger expenses during the period, compared to $112 thousand for the three months ended June 30, 2015. Non-interest income decreased by $120 thousand or 3.9% and non-interest expense had a modest increase of $177 thousand, or 1.2%. Salaries and other benefits expense increased $557 thousand, or 6.6%, as the Company’s active full-time equivalent employees grew to 280 at June 30, 2016, an increase of 17 from June 30, 2015. Increase in salaries and other benefits were offset by a decrease of $276 in other operating expenses, the largest of which was a $101 thousand reduction in the amortization of the core deposit intangibles. The increase in income tax expense is directionally consistent with the increase in profitability while the effective tax rates are comparable for both periods.

Six Months Ended June 30, 2016 Compared to Six Months Ended June 30, 2015

Net income available to common shareholders for the six months ended June 30, 2016 was $12 million, or $0.71 per diluted share, compared to $8.9 million, or $0.53 per diluted share for the six months ended June 30, 2015. The $3.4 million increase, or 38.7%, was primarily due to a $5.2 million increase in loan interest income driven by a 13% increase in average loan balance since the prior period. Non-interest income increased slightly by $92 thousand or 1.6% while non-interest expense had an increase of $451 thousand, or 1.5%. Salaries and other benefits expense increased $1.2 million, or 7.2%, as the Company’s active full-time equivalent employees grew to 280 at June 30, 2016, an increase of 17 from June 30, 2015, although seven employees joined the Company near the end of the second quarter of 2016. Increase in salaries and other benefits were offset by a decrease of $376 thousand in legal and professional expenses, a $352 thousand decrease in merger expense, and a $465 thousand decrease in other operating expense, the largest of which was a $202 thousand reduction in the amortization of the core deposit intangibles. The increase in income tax expense is directionally consistent with the increase in profitability while the effective tax rates are comparable for both periods.

 

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Average Balances, Interest Income and Expense, Yields and Rates

Three and Six Months Ended June 30, 2016 and 2015

The following tables present the Company’s average balance sheets, together with the total dollar amounts of interest income and interest expense and the weighted average interest yield/rate for the periods presented. All average balances are daily average balances (dollars in thousands).

 

     Three Months Ended  
     June 30, 2016     June 30, 2015  
     Average
Balance
     Interest      Average
Yield/Rate

(6)
    Average
Balance
     Interest      Average
Yield/Rate

(6)
 

Interest Earning Assets:

                

Deposits in other financial institutions

   $ 274,531       $ 417         0.60   $ 265,123       $ 246         0.37

Investment securities (1)

     374,888         1,415         1.51     265,367         1,051         1.58

Loans (2)

     1,908,945         23,165         4.88     1,673,185         20,644         4.95
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest earning assets

     2,558,364         24,997         3.93     2,203,675         21,941         3.99

Non-interest earning assets

     209,342              212,825         
  

 

 

         

 

 

       

Total Assets

   $ 2,767,706            $ 2,416,500         
  

 

 

         

 

 

       

Interest Bearing Liabilities:

                

Interest bearing transaction accounts

   $ 288,384       $ 99         0.14   $ 254,843       $ 98         0.15

Money market and savings deposits

     740,117         484         0.26     693,090         408         0.24

Certificates of deposit

     53,460         31         0.23     60,469         46         0.31
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest bearing deposits

     1,081,961         614         0.23     1,008,402         552         0.22

Securities sold under agreements to repurchase

     25,223         14         0.22     12,571         7         0.22

Subordinated debentures

     9,758         120         4.86     9,598         109         4.49
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest bearing liabilities

     1,116,942         748         0.27     1,030,571         668         0.26

Non-interest bearing demand deposits

     1,312,833              1,081,090         
  

 

 

         

 

 

       

Total funding sources

     2,429,775              2,111,661         

Non-interest bearing liabilities

     15,901              16,909         

Shareholders’ Equity

     322,030              287,930         
  

 

 

         

 

 

       

Total Liabilities and Shareholders’ Equity

   $ 2,767,706            $ 2,416,500         
  

 

 

         

 

 

       

Excess of interest earning assets over funding sources

   $ 128,589            $ 92,014         

Net interest income

      $ 24,249            $ 21,273      
     

 

 

         

 

 

    

Net interest rate spread (3)

           3.66           3.73

Net interest margin (4)

           3.81           3.87

Core net interest margin (5)

           3.67           3.79

 

(1) Average balances of investment securities available-for-sale are presented on an amortized cost basis and thus do not include the unrealized market gain or loss on the securities.
(2) Average balances of loans are calculated net of deferred loan fees and fair value discounts, but would include non-accrual loans which have a zero yield.
(3) Net interest rate spread represents the yield earned on average total interest earning assets less the rate paid on average total interest bearing liabilities.
(4) Net interest margin is computed by dividing net interest income by average total interest earning assets.
(5) Core net interest margin is computed by dividing annualized net interest income, excluding accelerated accretion of fair value discounts earned on early loan payoffs of acquired loans and interest recovered or reversed on non-accrual loans or other nonrecurring items based on management’s judgement, by average total interest-earning assets. See the reconciliation table for core net interest margin.
(6) Annualized.

 

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     Six Months Ended  
     June 30, 2016     June 30, 2015  
     Average
Balance
     Interest      Average
Yield/Rate

(6)
    Average
Balance
     Interest      Average
Yield/Rate

(6)
 

Interest Earning Assets:

                

Deposits in other financial institutions

   $ 287,967       $ 856         0.59   $ 231,481       $ 448         0.38

Investment securities (1)

     363,909         2,647         1.45     268,418         2,231         1.66

Loans (2)

     1,879,074         45,743         4.90     1,662,055         40,550         4.92
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest earning assets

     2,530,950         49,246         3.91     2,161,954         43,229         4.03

Non-interest earning assets

     211,959              207,466         
  

 

 

         

 

 

       

Total Assets

   $ 2,742,909            $ 2,369,420         
  

 

 

         

 

 

       

Interest Bearing Liabilities:

                

Interest bearing transaction accounts

   $ 279,590       $ 198         0.14   $ 246,577       $ 198         0.16

Money market and savings deposits

     733,399         995         0.27     672,023         791         0.24

Certificates of deposit

     54,690         64         0.24     62,196         97         0.31
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest bearing deposits

     1,067,679         1,257         0.24     980,796         1,086         0.22

Securities sold under agreements to repurchase

     22,882         25         0.22     11,671         12         0.21

Subordinated debentures

     9,739         237         4.81     9,583         216         4.46
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest bearing liabilities

     1,100,300         1,519